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BY J. LAURENCE LAUGH LIN 

BANKING PROGRESS 
MONET AND PRICES 
CREDIT OF THE NATIONS 
LATTER-DAT PROBLEMS 
INDUSTRIAL AMERICA 
THE PRINCIPLES OF MONET 

CHARLES SCRIBNER'S SONS 



BANKING PROGRESS 



BANKING PROGRESS 



BY 
J. LAURENCE LAUGHLLN, Ph.D. 

EMERITDS PB0FES3OR OF POLITICAL ECONOMY IN THE UNIVEBSITY OF CHICAGO 



NEW YORK 

CHARLES SCRIBNER'S SONS 

1920 






COPYBIGHT, 1920, BT 

CHAELES SCRIBNER'S SONS 
Published May, 1920 




©GLA571280 



PREFACE 

The story of growth, a progress from a lower to a 
higher plane, is always of absorbing interest in any field. 
In the evolution of our thinking on banking we have the 
complement to the history of our monetary development 
out of the greenback and silver stages. Although the 
two phases of progress are more or less related, the main 
significance of our banking progress is to be found in the 
gradual understanding of the workings of credit, and the 
emphasis which has inevitably been placed on the organi- 
zation and flexibility of credit as a part of our industrial 
growth. Even though the meaning of separate events 
was not clear at the time of their occurrence, a glance 
backward from our present position shows very dis- 
tinctly the country through which the road has been 
winding. 

Having been myself in close touch with the move- 
ments which from time to time marched with our mon- 
etary and banking progress, it has been inevitable that 
my presentation should have the marks of the period in 
which the questions at issue were fought out. Indeed 
much of the material in this volume came forth as a part 
of the effort to aid in directing public opinion to an in- 
telligent solution of difficult questions. Perhaps, for this 
reason, if for no other, they should have some historical 
value. But, in college courses on banking it may be 
worth while to have in compact form the sequence of 



vi PREFACE 

events which led finally to the possibility of the Federal 
Reserve Act. 

Inasmuch as active charge of the educative campaign 
leading up to the enactment of the Federal Reserve sys- 
tem was laid upon me, I have been repeatedly urged to 
set down the inside history of the movement. It is too 
soon, however, to publish any such account. But it has 
seemed justifiable to give to the public the exact bill with 
its commentary (Chapter IX) which was in 1912-1913 
offered by me to the framers of the bill. That it was mis- 
represented at the time goes without saying. Its perusal 
will show that its recommendations regarding the note- 
issues were not followed. One reason, to my mind, why 
its appearance now may be timely is the acute condition 
to-day of the note-issues and reserves, resulting from our 
war financing, which suggests that important changes 
may be ahead of us in order better to protect our note- 
issues from undue expansion, and better to separate our 
issue from our discount and deposit functions of bank- 
ing. It seems strange that in the most important bank- 
ing enactment of our history we should have gone back 
in effect to the practice of the old United States Bank 
wherein one cash reserve was kept for both demand- 
liabilities, notes and deposits. The account of the work- 
ing of the Federal Reserve Act for the five years since 
its enactment (Chapter XI) shows some shortcomings 
both in policy and structure which demand attention, 
especially in view of the responsible position that we 
have assumed in the world of credit. 

J. Laurence Laughun. 

Boston, March, 1920. 



CONTENTS 



CHAPTER I. THE STANDARD QUESTION 



§ 1. Evolution from Money to Credit 

§ 2. Gold Standard Not Firmly Established in 1900 . 

§ 3. Bonds Still Payable in Silver 

§ 4. Gold Must Still Be Stipulated in Private Contracts 

§ 5. No Means for Keeping Silver at Par with Gold 

§ 6. Separation of Gold Reserves from General Funds . 

§ 7. Politics Affected the Term of Bonds Refunded . 



1 
2 
4 
8 
8 
14 
16 



CHAPTER n. ELASTICITY OF BANK-ISSUES 

§ 1. Attention Directed to Elasticity 19 

§ 2. Inelasticity of National Bank-Notes 20 

§ 3. "Asset-Currency" Proposed in Baltimore Plan ... 26 

§ 4. How Received 28 

§ 5. Limited Only to Note-Issues 30 

§ 6. Errors Regarding Banks and Money 32 

§ 7. Elasticity Furthered by Monetary Commission of 1898 . 36 

CHAPTER in. INFLUENCE OF THE PANIC OF 1907 

§ 1. The Function of an Elastic Currency 38 

§ 2. Real Need for Elasticity in Lending Power 41 

§ 3. The Bankers' Plan of 1908 45 

§ 4. How to Meet a Crisis 47 

vii 



viii CONTENTS 

CHAPTER IV. THE ALDRICH-VREELAND ACT 



PAGE 



§ 1. Political Reasons for the Act 50 

§ 2. Legislative History of the Bill 54 

§ 3. Effect of the Bond Requirement 62 

§ 4. Both Bonds and Commercial Paper Accepted .... 64 

§ 5. Securities of Any Kind Admitted 66 

§ 6. Misconception as to Commercial Paper 75 

CHAPTER V. GUARANTY OF BANK-DEPOSITS 

§ 1. Origin of the Scheme 81 

§ 2. The Plan Stated 82 

§ 3. Different Positions of Noteholder and Depositor ... 85 

§ 4. The Depositor Acts Voluntarily 87 

§ 5. The Plan Socialistic 89 

§ 6. Safety of Deposits Depends on the Quality of Bank Assets 91 

§ 7. Guaranty Not a Cure for Panics 92 

§ 8. Power to Change Deposits into Notes 97 

§ 9. Relation of Guaranty to Bad Banking ...... 100 

§10. The Question of Technical Insurance 103 

§11. The Appeal to History 105 

CHAPTER VI. THE DEPOSITOR AND THE BANK 

§ 1. Relations of Depositors to the Bank ....... 107 

§ 2. The Guaranty as a Matter of Justice 108 

§ 3. Already Have Ultimate Redemption 110 

§ 4. Immediate Redemption Impossible 112 

§ 5. Absolute Security Asked 113 

§ 6. Guaranty Attempts to Equalize All Banks 114 

§ 7. Experience of Oklahoma 118 

§ 8. State vs. National Banks 120 

§9. Appeal for "More Money" 122 



CONTENTS ix 
CHAPTER VH. BANK-NOTES AND LENDING POWER 

PAGE 

§ 1. The National Monetary Commission 124 

§ 2. Function of Notes in a Crisis 125 

§ 3. In a Panic the Real Need Is a Loan 131 

§ 4. Lending Power in France and England 134 

§ 5. Essential Remedies for Crises 137 

CHAPTER VHI. POLITICAL HISTORY OF THE 
FEDERAL RESERVE ACT 

§ 1. Influence of the Act of 1908 143 

§ 2. The Aldrich Plan and Democratic Policy 145 

§ 3. Origin of the Bill 150 

§ 4. A Memorandum on the Political Situation 153 

§ 5, Methods of Congressional Legislation 155 

§ 6. Confusion as to Banking Functions 157 

CHAPTER IX. A PROPOSED BILL 

§ 1. Authorship of This Proposed Bill 160 

§ 2. Introduction 161 

§ 3. Centralization 7 163 

§ 4. Provisions on Organization 166 

§ 5. Discounts 171 

§ 6. The Treasury Board and Advisory Board 176 

§ 7. District or Reserve Associations 180 

§ 8. Note-Issues 184 

§ 9. Disposal of Bonds 198 

§10. Reserves 200 

§11. Disposal of Earnings 205 

§12. The Independent Treasury 208 

§13. Foreign Banking 209 

§14. Reports and Examinations 210 

§15. Clearings and Collections 212 



CONTENTS 
CHAPTER X. THE FEDERAL RESERVE ACT 



PAGE 



§ 1. Defects To Be Remedied 216 

§ 2. Control and Organization 217 

§ 3. Federal Reserve Banks 227 

§ 4. Note-Issues 237 

§ 5. Disposal of Bonds 245 

§ 6. Reserves , 249 

§ 7. The Organization of Credit 257 

§ 8. Clearings 268 

§ 9. A Discount Market 272 

§10. Foreign Banking 274 

§11. The Independent Treasury 275 

§12. The Entry of State Banks 276 

CHAPTER XI. WORKING OF THE FEDERAL 
RESERVE ACT 

§ 1. Establishment of a Discount Policy 278 

§ 2. Reserves 285 

§ 3. Admission of State Banks 288 

§ 4. Clearings 291 

§ 5. The Gold Basis 294 

§ 6. Foreign Relations 296 

§ 7. Effects of the War . 297 

§ 8. Notes 301 

§ 9. Expansion of Credit . .308 

§10. Lessons from Experience 312 

APPENDIX I 

Plan of the American Bankers' Association 319 

APPENDIX H 

Plan of the National Monetary Commission 326 

Index 347 



BANKING PROGRESS 



CHAPTER I 

THE STANDARD QUESTION 

§ 1. The concentration of public attention on burning 
monetary and banking questions of the day as they 
arose, as they were fought over and met more or less by 
legislation, may have prevented the most of us from seeing 
what has been the actual drift of monetary and banking 
thinking over the important period of the last twenty- 
five years. We may not have been able to see the forest 
for the trees. Yet these years have witnessed the most 
far-reaching changes in our understanding, as a country, 
of money and credit. The progressive steps in our de- 
velopment from questions of the standard to those of 
the elasticity of the currency and finally to those of the 
elasticity of credit are full of instruction. They record 
the evolution of our monetary and banking thinking. 
This evolutionary study, moreover, brings out the inter- 
relation of money with banking and of banking with 
money both in theory and in practice. As we look back 
upon them these events drop into a logical sequence; 
but at the time each step was taken we were then very 
much in the dark. In fact, we were forced into progress 
not so much by conscious wisdom as by the stern lessons 
of hard experience in two panics. 

The panic of 1893, due to a fear of falling to a silver 
standard, caused an upheaval of all our credit and bank- 
ing operations. In that year we broke with our silver 
folly and ceased further purchases of silver by law. 
Then succeeded such a stirring of public interest in money 
and banking that we may well date our present fortunate 

l 



2 BANKING PROGRESS 

situation to the progress then set in motion. It eame to 
be understood that a bad currency and banking system 
in itself could produce a ruinous upheaval of business. 
The business interests of the country, realizing that in 
the past monetary matters — as with the greenback and 
silver manias — had been neglectfully relegated to our 
politicians, at last became aroused and set to work to 
effect some essential reforms. To lay a foundation for 
succeeding changes the standard question was vigorously 
discussed. That was elemental for a further treatment of 
currency and credit. The cessation of silver purchases 
in 1893 had to be followed up by positive action to fix 
the standard. Then came the so-called Gold Standard 
Act of 1900. How far it has safely secured to us the 
gold standard is of first importance. 

§2. At the time of the passage of this legislation it 
was repeated by the public press, and assumed by the 
country, chiefly on the basis of reports emanating from 
Washington, that the act of March 14, 1900, whatever 
may have been its shortcomings in other directions, had 
at least firmly established the gold standard in the United 
States. The belief was generally prevalent that the 
election of a President pledged to the cause of free silver 
could no longer be a source of danger to our monetary 
system, because the gold standard had been placed by 
the new legislation beyond the reach of executive control; 
that the mere action of a future secretary of the treasury 
hostile to gold could not cause public or private obliga- 
tions to be paid in silver; and that nothing could now be 
done for silver except by new and positive legislation, a 
contingency which would be impossible so long as the 
Senate and the Executive favored gold. Hence we were 
assured that we could rest free from all danger of the 



THE STANDARD QUESTION 3 

"silver issue," which we heard on all sides was "dead." 
On the strength of this belief, political lines were drawn, 
and a plan of campaign was formed. That there had been 
a subtle game of politics played with our monetary legisla- 
tion through the influence of the Senate was unmistakably 
clear but was nothing unusual or surprising. It is not 
certain, however, that the general public was aware of 
the exact effect of the provisions of the new law, or in- 
formed how little had been done. Indeed, it may be 
a surprise to many to be told that, as regards the estab- 
lishment of the gold standard, not only had practically 
nothing new been introduced into the situation by this 
law, but that we have in general no new means of main- 
taining the standard which we did not have before the 
act was passed. If there had been possible danger from 
silver before March 14, 1900, the same danger still exists, 
except so far as we have been protected by the act of 
December 23, 1913. 1 

In speaking of the gold standard as firmly established, 
one means the obligation to pay gold whenever the word 
"dollars" is used. As every one knows, the word "coin" 
allowed an uncertainty as to whether a contract gener- 
ally payable in "dollars" could be paid in silver dollars 
(of 37134 grains pure silver) or in gold dollars (of 23.22 
grains pure gold). This uncertainty in regard to United 
States bonds in previous years seriously affected their 
value, and was one strong reason why new legislation 
was thought to be necessary to remove all doubt. It 
may, therefore, be a shock to some trusting people to be 
told that, in spite of the new law, a silver-loving secre- 
tary of the treasury could yet pay off large amounts 
of government obligations with silver dollars. If a free- 
silver President had entered the White Ho*use in 1901, 

l Cf. Chapter X, § 4. 



4 BANKING PROGRESS 

there would have been a large amount of obligations 
which could then have been paid in silver. 

§ 3. Even if the standard of payments and prices 
may now in practice be gold, as regards both government 
and private debts, it is important to know how perma- 
nent this situation is. For simplicity, the matter of 
government bonds will be discussed first. How did the 
act of March 14, 1900, affect the "coin" provision in 
which national obligations are payable? 

The contention which arose soon after the Civil War, 
that the debt of the United States was payable in paper, 
was settled in fact by the actual refunding of the whole 
debt under the act of July 14, 1870, which provided that 
the bonds issued under this law should be "redeemable 
in coin of the present standard value." Obviously this 
phrase referred to the standard coin existing before the 
act of 1873, and which then included silver dollars (of 
371 M grains pure silver) as well as gold dollars. Of 
course, silver dollars were worth more than gold dollars 
in 1870; and, as we all know, both gold and silver coins 
had been driven from circulation by the depreciated 
United States notes; but such facts are not to the point. 
Coin, in our law in 1870, included the silver dollar, whether 
it was in circulation or not. Hence all the bonds re- 
funded under the act of 1870 were payable at the dis- 
cretion of the Treasury either in silver or gold dollars. 

The act of February 12, 1873 ("the crime of 1873"), 
did not abolish the legal tender value of any of the few 
silver dollars which might then have been in existence. 
It simply omitted to provide for the future coinage of 
silver dollars (sec. 15 and 17) ; and added (sec. 14) : 

That the gold coins of the United States shall be a one- 
dollar piece, which at the standard weight of twenty-five and 
eight-tenths grains, shall be the unit of value, etc. 



THE STANDARD QUESTION 5 

It will be seen, then, no matter what other considera- 
tions may be adduced, that under the law in 1870 
"coin" certainly included silver dollars; and that the 
act of 1873 did not change this situation. And in de- 
claring the gold dollar to be "the unit of value" it did 
not forbid the use of silver dollars in any payments 
public or private. The limitation on the legal tender 
power of silver coins in 1874 was the only change intro- 
duced at that time. 1 

The subsequent fact of importance was that all bonds 
of later issue (until the Spanish War Loan of 1898) had 
been based upon the provisions of the act of July 14, 
1870. That is, the 4 per cents of 1907 were issued un- 
der that act. Also, any bonds put out under the terms 
of the Resumption Act of January 14, 1875, in order to 
obtain gold, were "of the same description as those issued 
by the act of July 14, 1870." Thus the extended 2s 
(of the loan of 1891), 5 per cents of 1904, and the 4 per 
cents of 1925, are covered by this latter statement. 
The United States bonds thus stood at the time of the 
passage of the act of March 14, 1900, all payable in 
"coin": 



4 per cent bonds, 1907 $559,652,300 

5 " " " 1904 100,000,000 

2 " " " 1891 (extended) 25,364,500 

4 " " " 1925 162,315,400 

3 " " " 1898 198,678,720 

$1,046,010,920 



The act of March 14, 1900, authorized a partial re- 
funding of the old debt into % per cent bonds, whose 
principal and interest was made specifically payable in 

1 The revised statutes of June 22, 1874, inserted a provision (sec. 3586) which 
limited the legal tender power of all our silver coins to sums not exceed- 
ing $5. 



6 BANKING PROGRESS 

"gold coin of the present standard value." It did not 
allow the refunding into the new 2s of the extended 2s 
of 1891, nor the 4 per cents of 1925 — in all a sum of 
$187,679,900. In May, 1900, however, the extended 
2s were called in for redemption, so that the bonds of 
1925 were the only ones in fact excluded. About the 
close of the European War (June 30, 1918) there still re- 
mained outstanding $118,489,900 of these 4 per cents of 
1925. Therefore, prevented only by the fact that they 
did not mature until 1925, a secretary, opposed to the 
gold standard, might, on a change of parties, have paid 
off on their maturity, in silver, since 1900, an amount 
of these 4 per cents varying from $118,489,900 to $162,- 
315,400. 

The possible dangers in the act, so far as our national 
bonds are concerned, have been practically removed by 
the subsequent working of refunding measures. But no 
thanks are due to the framers of this law. In effect, 
the uncertainty of the few years after 1900 has disappeared 
because practically all of the old debt has been refunded 
in later years into the 2 per cent consols of 1930 which 
are specifically payable in gold. 

With the above situation it must be kept in mind that 
the act of March 14, 1900, specifically enacted (sec. 3): 

That nothing contained in this act shall be construed to affect 
the legal tender quality, as now provided by law, of the silver 
dollar, or of any other money coined or issued by the United 
States. / 

That is, the act of February 28, 1878, which made the 
silver dollars "a legal tender, at their nominal value, for 
all debts, public and private, except where otherwise 
expressly stipulated in the contract," is still in operation. 
The outcome is a visible attempt to sit on two stools: 



THE STANDARD QUESTION 7 

in one word to declare that the gold dollar shall be the 
standard unit of value, and in another to declare that 
the silver dollar shall remain an unlimited legal tender. 
The political legerdemain in this action depends upon the 
inability of the public to separate the assignment of legal 
tender quality to the standard (in which prices and con- 
tracts are expressed) from the assignment of it to a token 
money (which should be redeemable in the standard 
money). Because the standard money is made legal 
tender, it does not follow that a medium of exchange 
(such, for example, as national bank notes, or checks and 
drafts) should have that quality. 

The dodging of the standard issue in regard to govern- 
ment obligations cannot be excused on the ground of 
inadvertence. The House bill (sec. 2) read: 

That all interest-bearing obligations of the United States 
for the payment of money, now existing or hereafter to be 
entered into, . . . shall be deemed and held to be payable 
in the gold coin of the United States as defined in section 1 
of this act. 

These words did not appear in the Senate bill, and were 
excluded from the conference bill. In short, for political 
reasons, the Serate leaders advisedly chose to modify 
the currency measure in such a way that it could still 
be said that a large part of our national obligations were 
payable in silver; while scheming for votes in the East 
on the ground of having established the gold standard, 
it would be possible to ask for votes in the Rocky Moun- 
tain States on the ground of having preserved the right 
to pay a large part of the bonds in silver. It must be 
said, therefore, that the new act established the pay- 
ment in gold of only a part of our government obliga- 
tions in existence at that time (and also that this amount 



8 BANKING PROGRESS 

depended upon how far they were later refunded into the 

new 2s) . 

§ 4. The consideration, however, of most importance 
to the business public is the certainty of the standard 
in ordinary private contracts drawn in "dollars," with- 
out a specific agreement to pay gold. Obviously, it 
may be said that the national bonds could not be paid 
in silver in any event until the time of maturity, and 
that such a fear need not give much cause for distrust. 
But as to private debts, falling due from day to day, 
every one realizes it to be a matter of present concern. 
Since the unlimited legal tender power of the silver dol- 
lar is retained for all obligations in which gold is not 
expressly stipulated, it is clear that all private contracts 
thus generally drawn could be liquidated in silver. The 
gold standard of payments, therefore, is not made obliga- 
tory for private debts. The new law manifestly did not 
establish the gold standard for the ordinary transac- 
tions of daily business life. If a lender of money wishes 
to secure repayment in gold, he must, to-day, as well 
as before this act was passed, expressly stipulate for 
gold in the contract. The act of March 14, 1900, did 
not give us any new protection in this regard. Hence 
we ought to give up the fiction that the new law "es- 
tablished the gold standard." 

§ 5. Since silver dollars can be paid for public and 
private debts in nearly as many cases now as before the 
act of 1900, the question then arises as to whether the 
permanence of the gold standard had been assured by 
any provisions for maintaining silver at par with gold. 
Certainly, a reader might say, so long as silver is kept 
in value equal to gold, no one would object to being paid 



THE STANDARD QUESTION 9 

in silver; and reference might be made to the fact that 
the act (sec. 1) not only declared the gold dollar to be 
"the standard unit of value," but also that "all forms of 
money issued or coined by the United States shall be 
maintained at a parity of value with this standard, and 
it shall be the duty of the Secretary of the Treasury to 
maintain such parity." To the innocent reader this 
may look like a veritable establishment of the parity of 
silver with gold. But it adds nothing that did not 
exist in the law before (in the acts of July 14, 1890, and 
November 1, 1893). * It pretends to establish parity by 
command, but it gives absolutely nothing with which 
to maintain parity. Suppose that Congress had ordained 
that the navy should have had all the old powder ex- 
changed for smokeless powder, and that it should have 
made it the duty of the secretary of the navy to make 
such exchange, and had provided no appropriation for 
this purpose, nor allowed any new machinery for carry- 
ing out the plan beyond what existed before. Should we 
not regard this as something more than trickery? Cer- 
tainly: it would be an insult to the intelligence of the 
public. In that monetary law, we had actually no means 

1 Act of July 14, 1890 (sec. 2): "That upon demand of the holder of any of 
the Treasury notes herein provided for the Secretary of the Treasury shall, 
under such regulations as he may prescribe, redeem such notes in gold or silver 
coin, at his discretion, it being the established policy of the United States to 
maintain the two metals on a parity with each other upon the present ratio, 
or such ratio as may be provided by law." 

Act of November 1, 1893: "And it is hereby declared to be the policy of 
the United States to continue the use of both gold and silver as standard money, 
and to coin both gold and silver into money of equal intrinsic and exchange- 
able value, such equality to be secured through international agreement, or by 
such safeguards of legislation as will insure the maintenance of the parity in 
value of the coins of the two metals, and the equal power of every dollar at all 
times in the markets and in the payment of debts. And it is hereby further 
declared that the efforts of the Government should be steadily directed to the 
establishment of such a safe system of bimetallism as will maintain at all times 
the equal power of every dollar coined or issued by the United States, in the 
markets and in the payment of debts." 



10 BANKING PROGRESS 

of maintaining silver dollars at par with gold which did 
not exist before the act was passed. Here again, the 
jugglery of the Senate leaders showed itself. The House 
bill ran (sec. 4): 

The Secretary of the Treasury is authorized and required 
to use said [gold] reserve in maintaining at all times the parity 
and equal value of every dollar issued or coined by the govern- 
ment; and if at any time the Secretary of the Treasury deems 
it necessary in order to maintain the parity and equal value 
of all the money of the United States, he may at his discretion 
exchange gold coin for any other money issued or coined by 
the United States. 

In short, the House bill set out to provide a gold re- 
serve to be used for the maintenance of the parity of 
all kinds of our money; but the Senate overruled this 
plan, and limited the use of the gold reserve solely to 
United States notes and treasury notes of 1890. That 
is, if the Treasury should find difficulty in keeping about 
579,000,000 of silver dollars at par with gold, he could 
not use the new gold reserve (for the replenishment of 
which provision was made by selling bonds). All the 
regulations of the reserve applied to the two forms of 
paper (amounting to about $426,000,000), while about 
575,000,000 dollars of silver, which carried a seignorage 
of over 50 per cent, were left without any direct means of 
redemption into gold, as a means of keeping the parity. 
I have said that the permanence of the gold standard 
depends upon the provisions of that law as to maintain- 
ing the parity between gold and silver; but we now see 
that no new means whatever had been given to ac- 
complish this end. Such methods of keeping silver at a 
parity with gold which existed before the act of March 
14, 1900, are still the only means we now have of assuring 
the continuance of the gold standard. That law had not 



THE STANDARD QUESTION 11 

given us any new methods of redemption. 1 Here we 
had an exhibition of gross cowardice on the part of Con- 
gress. Although no other enactments have been later 
made for gold reserves against United States notes or 
silver currency, yet so long as Federal Reserve notes 
remain redeemable in gold as required by the act of 
December 23, 1913, all other forms of money which are 
in practice used interchangeably with Reserve notes will 
have the same value. 

In one respect, however, that legislation bettered the 
chances of keeping our silver at par with gold. By the 
withdrawal of United States notes and national bank 
notes (except one-third of the new circulation) in de- 
nominations below $10, and by reducing the large silver 
certificates to small denominations to take their place, 
an additional use was created for the silver money, and 
therefore there will be less reason for its redundancy 
and consequently for its presentation at the Treasury 
in payment of customs in a process of indirect redemp- 
tion. By increasing the probability of keeping silver 
permanently in circulation for purposes of change it be- 
came less dangerous. 

But this gain was fully offset by the provisions of the 
act which affected the silver bullion behind the treasury 
notes of 1890, and which increased the quantity of 
silver dollars to be kept at a parity. Here we have 
another sop to Cerberus. From a sane point of view it 
is not much more creditable than the measure to coin 
the seignorage which was defeated some years before. 
Under the act of July 14, 1890, 168,674,682.53 ounces of 

1 How silver has been, in fact, kept at par with gold in the past by an in- 
direct system of redemption through the payment of customs, and by the 
complementary offer of gold to all creditors of the Treasury, I need not go 
into here. Cf. my History of Bimetallism in the United States, 4th ed., pp. 
253-255. Cf. Chapter X, § 4, for effect of the Federal Reserve Act. 



12 BANKING PROGRESS 

fine silver were bought by the issue of $155,931,002.25 
of treasury notes. The average price paid per ounce 
for this bullion was $0.9244;* and as the price soon fell 
about one-third, the value behind the notes became 
one-third less. But if this bullion were coined into silver 
dollars (at the rate of 37134 grains each), the 168,674,- 
682.53 fine ounces would yield about 218,000,000 silver 
dollars. Then, instead of $155,931,002.25 treasury notes 
to look after, there would have been a vastly larger bulk 
of silver dollars to be added to those previously coined 
under the act of 1878. The disposition of this bullion 
is a fair test of the animus of the new legislation. One 
bit of help existed in the permission to use enough of the 
bullion to increase the subsidiary coinage to 100,000,000 
dollars; and since the amount outstanding March 1, 
1900, was $80,101,151, it appears that an increase of 
nominal face value to the sum of about 20,000,000 dol- 
lars (or about 14,000,000 fine ounces) was possible. 
With this exception the act emphasized the policy of 
coining the rest of the bullion into dollar pieces and re- 
tiring the treasury notes. It is doubtless generally un- 
derstood how the terms of the act of July 14, 1890, has 
in fact brought about a gradual extinction of treasury 
notes of 1890. This process was established in the words 
(sec. 2): 

No greater or less amount of such notes shall be outstanding 
at any time than the cost of the silver bullion and the standard 
silver dollars coined therefrom, then held in the treasury 
purchased by such notes. 

Hence treasury notes, when redeemed by gold, would 
be reissued in order to keep the amount equal to the 

1 The rise in the price of silver bullion to over $1.30 in 1919 would make it 
possible for the Treasury to reduce its holdings at a profit. But this rise 
could not possibly have been foreseen. 



THE STANDARD QUESTION 13 

silver bullion plus the silver dollars held; but when re- 
deemed by silver, the treasury notes would be cancelled 
in order to keep the amount outstanding no greater nor 
less than the silver bullion plus the diminished number 
of silver dollars held. The released silver dollars, if re- 
turned in any way to the Treasury, could then become 
the basis of additional silver certificates (but never of 
treasury notes). This explains why the treasury notes 
were gradually being reduced in volume, coincident with 
an increase of silver dollars and silver certificates. 

The act of June 13, 1898 (the Spanish War Loan and 
Revenue Act), stimulated this process by the following 
requirement (sec. 34): 

That the Secretary of the Treasury is hereby authorized and 
directed to coin into standard silver dollars as rapidly as the 
public interests may require, to an amount, however, of not 
less than one and one-half millions of dollars in each month, 
all of the silver bullion now in the Treasury purchased in accor- 
dance with the provisions of the act approved July 14, 1890, 
. . . and said dollars, when so coined, shall be used and ap- 
plied in the manner and for the purposes named in said act. 

; Then the act of March 14, 1900, specified that as fast 
as silver dollars were coined under the foregoing laws, 
the secretary should (sec. 5) : 

retire and cancel an equal amount of Treasury notes whenever 
received into the Treasury, either by exchange in accordance 
with the provisions of this act or in the ordinary course of 
business, and upon the cancellation of Treasury notes silver 
certificates shall be issued against the silver dollars so coined. 

In this way that law brought about the cancellation 
of treasury notes without waiting for the former process 
of redemption by silver, thus hastening the conversion 
of treasury notes into silver certificates. The only ad- 



14 BANKING PROGRESS 

vantage to be gained from this action was the final dis- 
appearance of one of the too many kinds of money which 
make up our circulation. 

When that law came into force there were only $86,- 
776,000 treasury notes outstanding, supported by bul- 
lion costing $77,402,692, plus 9,373,308 silver dollars. 
The number of ounces of fine silver uncoined at that 
da!' a. m about 85,550,000. Consequently, instead of 
$!.>,} ,000,000 in treasury notes, there would be about 
200,000,000 in silver dollars when conversion had been 
completed, or an increase of not less than 45,000,000 
dollars. This increased volume of silver dollars would 
raise the total issue (including the 378,000,000 dollars 
coined under the act of 1878) to about 578,000,000 dol- 
lars. For the maintenance of this vast sum at a parity 
with gold, when each silver dollar was then actually 
worth only about 47 cents, there was absolutely no 
method of direct redemption in gold. And the act of 
March 14, 1900, gave no new provisions whatever to 
accomplish this end, or to support its windy and virtuous 
order to the secretary to maintain the parity. So far as 
any new power was given him to carry out the purpose, 
Congress might as well have ordered the secretary to see 
that every citizen of the United States should have blue 
eyes. 

§ 6. It will be noticed that all the machinery for a 
gold reserve, its increase to $150,000,000, its replenish- 
ment from sales of bonds, etc., had to do solely with pro- 
tection to the United States notes and treasury notes of 
1890. Hence, when the latter have ceased to exist, the 
gold reserve will remain only for the government paper, 
with nothing in reserve for our token silver. The omi- 
nous feature of this arrangement is the evident intention 



THE STANDARD QUESTION 15 

to regard the United States notes as a permanent part of 
the circulation. No suggestion whatever is made as to 
the future retirement of any portion of this form of our 
money. That, it is clear, must be reserved for future 
reforms. 

But although the act of 1900 gave us no firmer hold 
on the gold standard, and did nothing to remove the 
United States notes, it has, indeed, secured to us a re- 
form which, in possibilities of safety in the future, wholly 
outweighs any other feature of the act. No one who has 
watched carefully the origins of our paper-money de- 
lusions will fail to realize how dangerous was the con- 
fusion in the minds of our legislators in the past between 
the monetary and the fiscal functions of the Treasury. 
It was this confusion which, in 1862, led to borrowing 
in the form of demand obligations to be used as money; 
to a depreciation of the standard of prices; to the de- 
struction of our credit in the loan market; to the appear- 
ance of speculation and unsettled business conditions — 
and all the evils of a fluctuating currency. Since the 
resumption of specie payments in 1879, the gold reserve 
had been a part of the general fund applicable to fiscal 
purposes in cases of deficit as well as to the redemption 
of our paper money. For this reason we got into serious 
trouble when deficits used up the gold reserves, because 
fiscal operations took immediate effect on the reserves 
protecting the character of our standard of prices and 
contracts. No mere question of revenue and expendi- 
ture of the general treasury should ever be permitted to 
have such an influence on our standard that business 
could be thereby seriously crippled. It is such an anom- 
alous situation as this which we are happy to say has 
been made impossible by the distinct separation of the 
funds used for reserves behind the government paper 



16 BANKING PROGRESS 

from other cash in the hands of the State. This appeared 
in the new form of treasury statements. In the years 
to come nothing we have accomplished ought to have 
done more than this one provision to clarify the public 
mind as to the true status of our paper money, and to 
save us from stupid blundering. While this part of the 
act excited little comment in the press, it was of first 
importance as a piece of positive legislation. This one 
measure would alone have made the act prominent in 
the history of monetary legislation since the Civil War. 
But we again relapsed into much the same difficulty with 
the Federal Reserve Act during the war (see Chapter XI). 
The regulations by which the gold reserve for govern- 
ment paper is to be maintained, and the details of re- 
demption, are doubtless clumsy, and drawn in such a 
way as to escape political attack; but there is little reason 
to believe that they will not work out successfully in 
practice. Certainly the redeemability of the United 
States notes and the treasury notes of 1890 was provided 
for beyond peradventure in the permission to sell bonds 
to protect the gold reserve. But the separation of the 
issue and redemption departments from the general 
treasury funds makes entirely clear that no gold in the 
former can ever be used in the indirect or direct redemp- 
tion of silver dollars; and that the character of the silver 
circulation will depend wholly upon the composition of 
the free treasury balance. If gold should not readily 
come in for revenue, or if redundant silver or other cur- 
rency should be paid in instead, the free balance would 
more quickly than of old indicate the difficulty of main- 
taining our large silver circulation at a parity with gold. 

§ 7. This act, however, was not concerned only with 
the standard. It also touched on the subject of banking. 



THE STANDARD QUESTION 17 

The sections of the law relating to banking, however, 
may be dismissed in a few words, because the changes 
proposed were unimportant. The reduction in the tax 
on circulation, and the increase in the amount of notes 
issued by banks to 100 per cent of the value of the bonds, 
had some influence in expanding the circulation. 

The refunding provisions, however, were of an impor- 
tant character. They were important because, in order 
to serve a political end, one of the generally accepted 
principles of finance was violated. There can be no 
doubt that the extension of the term of the new bonds 
to thirty years had only political considerations behind 
it. It is almost inconceivable in a modern community 
that a State should put its bonds in a form where they 
cannot be paid off within a reasonable period. After the 
extended 2s were paid off (a process then going on), and 
after all the old bonds were refunded into the new loan, 
our national debt could not be reduced (except by pur- 
chase in the open market) before the 4s of 1925 matured. 
So flagrant an abuse of sound finance could be explained 
only on the supposition that a supply of national bonds 
would be assured for a generation to come in quantity 
sufficient for the security of the national bank circulation. 
Such was the adroit move by which the Senate leaders 
supposedly succeeded in shelving for decades the demand 
for an elastic bank currency based upon commercial 
assets. And if the refunding measure released a consid- 
erable sum from the Treasury in payment of premiums, 
and caused an enlargement of the banking circulation, 
it would be supposed to ease the money market during 
a presidential year, aid in the "prosperity" argument, 
and assist in the political purposes of the party in power. 
In general, it can be said that the new measure did not 
add anything of value to the machinery by which the 



18 BANKING PROGRESS 

banks were enabled to adjust the supply of currency 
automatically to the needs of the public. Many small 
banks, and some large ones, would no doubt be established, 
or come into the system, but after that increase, the 
rigidity of the old system would remain with all its well- 
known characteristics. 



CHAPTER n 

ELASTICITY OF BANK-ISSUES 

§ 1. In the United States after the long struggle for 
a stable standard of prices — ranging over the greenback 
and silver campaigns from 1874 to 1896 — the attention 
of intelligent reformers seemed to have centred on ob- 
taining an elastic currency. Elasticity meant, of course, 
the power to contract as well as to expand according to 
the needs of trade and credit. Although the tremendous 
losses from the panic of 1893, due to the fear of a silver 
standard, directly led to the legislation on the standard 
in 1900, there was running through all minds in the 
same years, mingling with the discussion on the standard, 
an accompaniment of deep discontent regarding the con- 
dition of our paper circulation, its safety, and especially 
its flexibility. It was not then perceived that the pivotal 
matter, underneath all questions of paper money and 
its elasticity, was a flexible working of credit. It was then 
believed that our paper currency, whether issued by the 
government or by the banks, if properly conditioned, 
would provide all the elasticity needed by a good currency 
system. Indeed, the power to issue notes was regarded 
by most public men as the central point of currency 
philosophy. If the government should retain the con- 
trol over paper issues, according to some persons, credit 
and prices would be under control. Or, if banks were to 
be allowed to issue notes, all legislation should lay em- 
phasis on these notes, their quantity, their relation to the 
bank's capital, and their safety; yet all the while, the 
banks, through their credit operations, carried out by 

19 



20 BANKING PROGRESS 

checks drawn on deposits, were exercising a currency 
function far and away more extensive and important 
than any performed by paper money. In the evolution 
of our thinking on money and credit an understanding 
of these latter operations did not early come to the front. 
Meantime, our minds were mainly occupied — as they 
had been in fact since early in the previous century — 
with questions as to the issue of notes. Fundamental 
to the settlement of these problems was a weighing of 
the relative value of a system of governmental issues in 
contrast with that of bank-issues. 1 That we should, 
because of inherited prejudices and the accidental legis- 
lation of the Civil War, in spite of opposing experience in 
Great Britain and on the Continent, have clung to the 
issue of governmental paper (although limited in amount) 
even to the present day, and after the passage of the 
Federal Reserve Act, is a curious case of persistency in a 
dangerous expedient. 

Nevertheless, even though the greenback has by tacit 
acquiescence remained as a rigid part of our currency, 
there has arisen without debate and almost uncon- 
sciously a wide-spread sentiment in favor of bank-issues. 
This opinion grew no doubt because of a belief that the 
well-recognized inelasticity of the national bank notes 
could be removed. 

§2. It is well here briefly to recall the reasons why 
the old national bank notes, before the enactment of 
the Federal Reserve Act, were signally inelastic; for they 
are typical of any system of issues secured by bonds. 

First, these notes were inelastic because they could 
not be readily expanded to meet the needs of any sudden 
demand. The method of their issue is well known: 

1 Cf. Laughlin, Money and Prices (1919), chap. X. 



ELASTICITY OF BANK-ISSUES 21 

The national banks could take out new circulation only 
by securing and depositing United States bonds with 
the comptroller of the currency. Since these notes 
were printed from separate plates for each bank, the 
sending in of bonds, the printing of the notes in Wash- 
ington, their shipment to the bank, and the signing of 
the notes by the respective bank officials, caused more or 
less delay before the notes were ready to be issued. At 
least three weeks were thus consumed. This delay was 
such that, unless foreseen, bank-notes could seldom be 
obtained quickly enough to meet a sudden demand for 
cash. 

Moreover, the motive for issuing notes based on bonds 
is not the needs of business, but the possibility of profit 
to the bank. The prospect of profit, however, is compli- 
cated with many considerations outside the control of 
the bank. The price which must be paid for bonds 
necessarily affects the willingness of the banks to issue 
notes; and yet in past years the quantity and kind of 
government bonds available, and consequently their 
price, have varied greatly. The prices of bonds may 
fluctuate either because of changes in the credit of the 
government, or changes in the current rate of interest. 
If our credit improves, bonds paying more than a normal 
rate rise in value; or, other things remaining the same, 
a fall in the market rate of interest will cause a rise in 
the price of bonds having a fixed return. Moreover, the 
term for which a bond runs affects its price: as a bond 
approaches maturity it will drop to par; if yielding more 
than the market rate of interest a long-term bond, not 
paying as much as a short-term bond, might command 
a high premium. 

A bank makes its profit by the discount on a loan. If 
a borrower, however, wishes bank-notes, the profit to 



22 BANKING PROGRESS 

the bank will be affected by the expense of issuing notes; 
that is, the gain from the market rate on the loan would 
be affected by the interest paid on the securities required 
to obtain the notes. A high market rate of interest t *nds 
to prevent the issue of notes secured by bonds. Instead of 
investing in these bonds, by lending their funds direct to 
borrowers who ask only a deposit-account and the right 
to draw on it with checks, a bank can earn larger profits. 

Also, until 1900, notes to only 90 per cent of the par 
value of the bonds could be issued. That is, taking $100 
out of the cash resources of a bank in order to obtain 
$90 (and later $100) in their own notes meant that giv- 
ing credit to those wishing a note-liability (instead of a 
deposit-liability) crippled the power of a bank to earn 
profits. Hence in the years 1883-1893 there was a 
marked decline in the national bank circulation. There- 
after, from $178,713,692 in 1893, it grew to $353,742,- 
186 in 1901, and to $759,157,906 in 1913 (the year of the 
Federal Reserve Act). 

Changes in conditions outside the control of the banks 
produce an effect on their profits and on the amount of 
the circulation issued. Experience has shown that a 
system of notes secured by bonds is inconsistent with the 
automatic adjustment of the quantity of the circulation 
to the demands of the public and the needs of trade. 
When the demand for loans is great and the market rate 
of interest is high, there is little profit in issuing notes; 
in short, when the demand may be urgent, the supply 
may not be forthcoming. 

On the other hand, if the country is suffering from 
business depression, if funds are accumulating in the 
banks, and if the market rate of interest is low because 
there are few opportunities of profitably employing cap- 
ital, then it would be natural to expect the banks to use 



ELASTICITY OF BANK-ISSUES 23 

superabundant funds in buying safe bonds of a low rate 
of interest. Therefore, at a time when the demand for 
loans is slight and the rate of discount is low, it would be 
easy for the banks to invest in bonds and thereby obtain 
notes. In short, when there is no demand, the supply 
is easily obtained. It needs no further comment, conse- 
quently, to see that such a system of note-issues works 
at cross purposes with the needs of the public. With a 
deposit of bonds for security of notes, there is likely to 
be no supply of notes at a time when most needed and an 
abundant supply when least needed. 1 

Moreover, a bond-secured circulation is limited by 
the supply of available bonds having the circulation 
privilege (i. e., the right to be deposited to secure notes). 
The maximum of such notes is thus restricted, not by 
the needs of business, but by the total supply of bonds. 
In the years before the European War, when our national 
debt was being reduced, this supply of bonds was so 
limited that the 2 per cent bonds possessing the circula- 
tion privilege were thereby given a value far above their 
investment price. Also, the practice of the Treasury in 
requiring bonds to be deposited by banks to the amount 
of government funds received created an additional de- 
mand for bonds. Thus at the very time when there was 
a large Treasury surplus there was a tendency to limit 
the bonds available for note-issues; and yet this was a 
time of general prosperity when a demand on the banks 
for loans, and incidentally for currency, would be strong. 
Of course, since the large issue of government bonds 
during the European War, there could be no lack of bonds 
for this purpose, if it were a desirable one in itself. 

1 See Report of the Monetary Commission of 1898, p. 228, and also sees. 133-136, 
103-110. Also see Banking Reform, National Citizens League (1912), chaps. 
IV and VIII. 



24 BANKING PROGRESS 

In the second place, national bank notes were inelastic 
because their contraction was even more delayed than 
their expansion. Elasticity, as already said, implies two- 
conditions: (1) immediate expansion whenever there is 
an increased demand for currency; and (2) prompt re- 
tirement as soon as the need for it has passed. The 
proper supply needed by the public is always automati- 
cally adjusted to the need, if there is a system of easy 
and immediate redemption. In short, immediate re- 
demption necessarily secures not only the parity of the 
notes but the impossibility of a superabundant circula- 
tion. 

The redemption of national bank notes was imperfect. 
The very uniformity and safety of these notes consti- 
tuted the reason why they would not be sent in for re- 
demption by any one else than the issuing bank. Its 
circulation being out in all parts of the country, a bank 
could seldom get hold of its own notes. Only as they 
happened to be sent in to the one redemption agency in 
Washington could a bank secure a return of its own notes. 
To withdraw its circulation, a bank could deposit lawful 
money with the Treasury to the amount of the notes to 
be retired, and thereupon take away the bonds kept for 
their ultimate redemption. This "doomed circulation" 
remained out in the hands of the public until they were 
either sent in by other banks or became so mutilated 
that they would appear at the redemption agency to be 
exchanged for fresh notes. Therefore, not only was the 
withdrawal of notes unreasonably delayed, but the con- 
traction was accomplished only by the hiding away in 
the Treasury of an equivalent sum of lawful money. 
Moreover, by the act of July 22, 1882, no more than 
$3,000,000 could be withdrawn in any one month; on 
March 4, 1907, this amount was fixed at $9,000,000. 



ELASTICITY OF BANK-ISSUES 25 

Consequently, when, in times of an urgent demand for 
notes, a bank was induced to issue notes temporarily, it 
knew that it would be practically impossible to with- 
draw them until long after the emergency had passed. 
Sometimes a bank found it had outstanding all the notes 
it could care for, and when asked for notes by its cus- 
tomers could get them only by borrowing them from 
banks (usually large city banks) which had not fully 
used their privilege of issue. 

So far as the actual use of money is concerned, when 
passed from hand to hand, there are seasonal variations 
in the demand, arising from methods of doing business, 
and especially from the ebb and flow of industrial activ- 
ity at different seasons. Thus there are varying demands 
for a medium of exchange for pay-rolls, payment of 
dividends on stocks and bonds at quarterly or semi- 
annual periods, or the marketing of the crops in the 
autumn. For such purposes the characteristic of ex- 
panding and contracting with seasonal needs was regarded 
as very important. Of course, the national bank notes 
lacked such elasticity. For many years, while the at- 
tention of currency reformers was concentrated on elas- 
ticity of the currency, the Canadian and Scotch banking 
system was highly praised by contrast with our own in 
this respect. It was found that the life of a national 
bank note, due to the extreme slowness of redemption, 
was about two years, while that of a Canadian bank note 
was only thirty days, and of a Scotch note eighteen 
days. 1 

The sum of the whole matter is that under the existing system 
of bank-notes based upon government bonds, normal and 
authentic expansion and contraction of the currency, in re- 
sponse to needs of trade, is flatly impossible. The currency 

1 See Report of Monetary Commission of 1898, sees. 207-225. 



26 BANKING PROGRESS 

supply may be greatly enlarged in the dull midsummer months 
and suddenly contracted when the active autumn business 
season begins. It may increase rapidly at a time when trade 
reaction has reduced to a minimum the necessities for even the 
existing bank-note supply, or it may be as rapidly reduced 
when large harvests, full employment of labor, and active 
hand-to-hand use of currency most need a larger circulating 
medium. That there is no remedy for this abnormal situation, 
except the substitution of some other system for that which 
prescribes the United States Government bond as a basis for 
bank-note issues, every economist at all familiar with the 
question agrees. 1 

§ 3. This matter of the inelasticity of our currency 
was probably overemphasized. It was not realized that 
it was only one phase of a larger question. It was, of 
course, true that a certain marginal elasticity on the 
general amount of our circulation was quite important. 
Nevertheless, it is now clearly seen that a few years ago, 
under a demand for an elastic currency, it was supposed 
that issues of notes would be a remedy for the disasters 
of a financial panic. Such a point of view ignored the 
deeper and wider question of credit and the lending power 
of the banks. In a time of panic what a hard-pressed 
business man wanted was a loan, and, if this was granted, 
he found a perfectly elastic medium of exchange at all 
times in the deposit-currency (i. e., checks drawn on de- 
posit-accounts). The resort to the issue of clearing- 
house certificates in times of stress was not made to 
furnish a medium of exchange, but to make loans possible. 
The matter of elastic bank-notes, although necessary, 
was certain to be overshadowed sooner or later by the 
demand for a better organization of credit. One of the 
important objections to the old national banking system 

1 A. D. Noyes, History of the National Bank Currency, p. 20 (issued by Na- 
tional Monetary Commission). 



ELASTICITY OF BANK-ISSUES 27 

was that the bond requirement really limited the lending 
power of a national bank. To see these things, however, 
there was needed a long education and a slow evolution 
in our thinking about banks. Banking progress did not 
come at once. The greater need of the elasticity of 
credit, which was later brought about by the Federal 
Reserve Act of 1913, was not then understood. 

It was the experience with the national bank notes 
(all other forms of our paper being rigidly inelastic) that 
forced attention on remedial measures aiming at elas- 
ticity in general. Then began the agitation against a 
bond-secured system of note-issues and for some method 
of safely securing the notes by commercial assets which 
has since gone on to its final consummation in the Federal 
Reserve Act. The fear of undue expansion and of lack 
of security behind such notes produced no little timidity 
in venturing on new experiments. This point of view 
accounts for the constant endeavor in all schemes to re- 
late the amount of issues to a percentage of the capital 
of the issuing bank; yet the issues are in truth func- 
tionally related not to the capital but to the assets of the 
bank. 

It is interesting to record that the first definite pro- 
posal to use commercial assets came from the American 
Bankers' Association in 1894, and was known as the 
"Baltimore Plan." Although it did not come to fruition, 
it was important in blazing the way for later possibilities. 

In brief, it was proposed to allow the national banks 
under federal supervision to issue circulating notes se- 
cured by (1) a first lien upon the assets of the issuing bank, 
(2) the double liability of shareholders, (3) the 5 per 
cent redemption fund, and (4) a 5 per cent guaranty 
fund. In case of failed banks the guaranty fund could 
be replenished, if necessary, by use of the prior lien. It 



28 BANKING PROGRESS 

will be observed that the noteholder was given a prior 
claim over the depositor, thus retaining the intent of the 
former method of segregating assets in the form of bonds 
to protect the notes. In addition, the amount of notes 
was restricted and taxed to insure their retirement when 
the need for their issue had disappeared. To 50 per cent 
of the paid-up, unimpaired capital of the bank the tax 
on the notes was Yi of 1 per cent; and additional issues 
were allowed up to 75 per cent of the capital, but subject 
to a much heavier tax. Thus the maximum issue per- 
mitted was 75 per cent of the capital. This was a seri- 
ous check on elasticity. 

§ 4. How this proposal was received at the time and 
the attitude toward it belongs to our monetary his- 
tory. The Baltimore Plan, thus presented, dealt solely 
with the function of note-issues of banks, totally disre- 
garding the two other important functions, namely, de- 
posit and discount. It did not propose to modify ex- 
isting law with regard to the immediate redemption of 
bank-notes. The redemption fund of 5 per cent in 
Washington and the usual requirements for redeeming 
notes at then counters were to remain untouched. The 
plan proposed a radical and drastic change in the pro- 
visions of the existing law as to the ultimate redemption 
of national bank notes. At that time the ultimate re- 
demption and security for bank-notes were United States 
bonds. A bank could then issue notes up to 90 per cent 
of the par value of the bonds. The Baltimore Plan in- 
stead proposed a 5 per cent guaranty fund held by the 
government, then a prior lien on all the assets of the bank, 
and if this were insufficient, then on the stockholders' 
liabilities. 

The security to the note-issues was large and unques- 
tionable. The prior lien on the assets is not really un- 



ELASTICITY OF BANK-ISSUES 29 

derstoocL As is proper, it gave the noteholder a lien 
before the depositor on all the assets. The limitation of 
the amount of issues to 50 or 75 per cent of the unim- 
paired paid-up capital was a mere formality, so far as 
security goes. There is no measure whatever of the as- 
sets of a bank in comparing them with its paid-up cap- 
ital. The item of loans may be enormously larger than 
capital, and that is so in every strong, well-trusted bank. 
For example, some years ago the Chemical Bank of New 
York had a capital of $300,000, but loans of perhaps 
$15,000,000 or $20,000,000; and the relation of capital 
to assets was much the same in such a bank as the First 
National Bank of Chicago. Therefore the limitation of 
issues to a certain percentage of capital gives a security 
in assets out of all proportion merely to capital. 

Secretary Carlisle modified the Baltimore Plan in favor 
of greater security to noteholders. He proposed, first, a 
deposit of 30 per cent of the circulation in legal money 
with the government; then, second, the safety fund of 
5 per cent; third, a requirement upon all other banks to 
fill up deficiencies in these two funds of any failed bank; 
fourth, a lien upon all the assets, and, fifth, a further lien 
upon the stockholders' liability. 

Both these plans mentioned agreed in limiting the issues 
to a percentage of 50 or 75 per cent of the paid-up cap- 
ital. Hitherto we had been complaining of the inelastic 
character of our "greenbacks" as a reason for their re- 
tirement; but in the new plans it was made impossible 
to issue more notes than a certain percentage of bank 
capital. But national bank capital is not an elastic 
thing. Indeed, it had not changed greatly in years. In 
1875 it was $504,000,000, in 1893 it had increased only 
to $678,000,000; while the total amount of our circula- 
tion increased from $754,000,000 in 1875 to about $1,600,- 
000,000 in 1893; and population had in the same period 



30 BANKING PROGRESS 

grown from 41,000,000 to 66,000,000. We see therefore 
that the new scheme set up an inelastic barrier of bank 
capital, and determined the amount of the issues by 
taking a certain percentage of that inelastic capital. 
To this extent the new schemes, while to be approved in 
general, were defective. 

Most of the objections made against the Baltimore 
Plan and in the general discussion of currency at that 
time were based upon the insufficiency of the supply of 
gold, as if that had caused a fall of prices, and the need 
of more money. From 1850 to 1875 there had been pro- 
duced as much gold as was produced from the discovery of 
America in 1492 to 1850 — three hundred and fifty-seven 
years. In forty years we had produced about $5,300,- 
000,000 of gold as against the production before 1850 of 
about $3,000,000,000. Judging from the statistics of 
Adolph Soetbeer, the German statistician, on the product 
of gold and silver, the difficulty is to discover what had 
become of the gold. In the last statement of the Mint 
preceding 1894 of the amount of gold in all the currencies 
of the world, even including such countries as Japan, the 
total amount of gold in use as money amounted to about 
$3,500,000,000. We had in existence in 1850 probably 
not more than $2,000,000,000 of gold. 1 We produced 
from 1850 to 1893, $5,300,000,000 of gold. We have 
difficulty in accounting for nearly $1,800,000,000 of gold 
that we cannot find in the currencies of the world. Since 
that time gold has gone on increasing. There is more 
gold to-day in the circulation of the world than there has 
ever been at any time in history. 

§ 5. In all these plans we were really aiming to pre- 
vent the difficulties experienced in 1893, when we re- 

1 See Laughlin, Money and Prices, p. 86. 



ELASTICITY OF BANK-ISSUES 31 

sorted so largely to clearing-house certificates. Let us 
see just what took place, and what the remedy should be. 
In normal times before a panic one man sells his goods 
expressed in terms of the standard money, drawing a bill 
on the buyer or getting his note, discounting the bills or 
notes at his bank, getting a corresponding deposit, and 
paying his own debts by drawing checks on the accounts 
thus created. And so with others; not only this man, 
but most men in ordinary business. Not more than 5 
per cent of wholesale transactions are carried on by 
actual money used as a medium of exchange. Ninety- 
five per cent of the goods are transferred by some credit 
device; the media of exchange are not wholly money but 
mainly bills and checks. These latter media are elastic, 
perfectly elastic. They expand exactly in proportion to 
the work to be done. 

Then what happens in a panic like that of 1893? 
Many purchasers have obligations maturing at fixed 
dates, and these obligations are drawn in terms of the 
standard. This standard is gold. Every one is liqui- 
dating — selling property, stocks, bonds, in order to get 
that which would meet these obligations. If they are 
not met, financial failure is the result. Is it actual coin 
or bank-notes that every one needs to get means of pay- 
ment? If a bank will lend him on his assets, and credit 
him with a deposit, he is safe. So long as a bank is 
able and willing to give loans on assets, that is, translate 
them into means of payment, all goes well. In short, 
the crux of the whole matter is traceable to the banks. 
Can they expand loans sufficiently? Can they furnish 
all the means of payment needed to enable every bor- 
rower having bankable goods to avoid bankruptcy when 
his obligations mature? That is the real question. Is 
there elasticity of credit ? In a panic all depends on 



32 BANKING PROGRESS 

the answer to this. Now, how does the elasticity of 
note-issues affect the situation ? 

In the stress of a panic, what is needed is not elas- 
ticity in only one form of immediate liability. In order 
to enable a bank to loan, and so stop the pressure, it is 
not enough to have an elastic limit only to the note- 
issues. The same operation can be carried through by 
a deposit-account, and that method is unrestricted by 
law. Indeed, as a matter of fact, the largest banks make 
almost no use of their note-liability, and use only the 
deposit-liability. We see, therefore, that calling atten- 
tion solely to the elasticity of note-issues in the Balti- 
more Plan does not meet the whole need. Grant that 
we have this elasticity of note-issues, we shall not then 
be able to meet the difficulties which will inevitably 
arise in times of stringency as certainly as the sun rises 
in the east. To be sure, so far as the note-liability is 
used from hand to hand in retail and small transac- 
tions, it is well to have the issues of them answer promptly 
to the demand, provided safety is secured. Then both 
forms of immediate liability — first, deposit-credit, and 
second, note-issues — will freely respond to the demand 
of customers, whenever a bank can lend at all. But it 
must not be supposed that an elastic note-issue is a uni- 
versal panacea for commercial crises. 

§ 6. Here it may not be amiss to refer to an elemen- 
tary matter in banking. A bank makes its profit through 
buying a debt due in the future by giving for it a debt 
due at the present time. That is, it buys a note, or dis- 
counts a bill, say, at sixty days, with collateral, and gives 
for it an immediate liability. But the forms in which a 
bank gives an immediate liability are two — which one 
it will use depends on the customs and preferences of its 



ELASTICITY OF BANK-ISSUES 33 

clientele. First, if its customers are engaged in large 
transactions, as in a city, they use checks almost entirely. 
Therefore the bank finds that making a deposit-account 
is the form of immediate liability which will be generally 
used. Second, if its customers always pay money from 
hand to hand, the bank finds that its borrowers ask for 
that form of immediate liability called a note-issue. 
Other things being equal, it makes no difference to the 
profit of a bank which is used; the choice between the 
two depends upon its customers. 

It seems that there existed in this country a most ex- 
traordinary prejudice against banking. It must be based 
only on ignorance of what the banking business is. 
Therefore, it may be well to explain in brief what a bank 
is. It is not different in essence from a store which sells 
hardware or corn. It has its legitimate function in busi- 
ness, just as any shop has. It buys and sells something. 
It gets a profit because it buys a larger debt payable in 
the future with a smaller debt payable at the present 
moment. Its profit is there and nowhere else. It does 
not make its profit on the issue of notes. 1 

The mental confusion on monetary subjects is too often 
connected with a failure to distinguish between the pro- 
duction and the exchange of goods. Money is a machine 
by which goods are exchanged after they are produced. 
It is not a factor of production. Increasing the amount 
of money does not increase goods in other forms. By 
increasing the number of railways between Chicago and 
St. Paul, the number of bushels of corn and wheat to be 
carried on those railways is not increased. An increase 
of the means of transportation does not increase the 
quantity of goods to be transported. It may, indeed, 

1 For a full discussion on this point, see Report of Monetary Commission of 
1898, sees. 103-110. 



34 BANKING PROGRESS 

even produce the opposite effect; an excessive transfer 
of saved wealth into railway embankments might leave 
less to be devoted to the production of goods seeking 
transportation. The case is precisely the same with 
money. Money is only the machinery by which goods 
are exchanged against one another. No matter how 
valuable, it is not wanted as a medium of exchange for 
its own sake, but for what it will buy. We do not eat 
or drink the money itself. It is only a means to an 
end; it is like the bridge over a river— a mechanism by 
which we get goods from one shore to the other. To 
confuse money with the goods it transfers is like failing 
to distinguish between the bridge and the corn and pork 
which pass over it. To suppose that coming more silver 
would make the country richer is to suppose that the 
more bridges we build the more corn and pork we shall 
have; or that the more railways we build between 
Chicago and New York, the more goods there will be 
to pass to and fro. Once the real work performed by 
money is apprehended, the fallacy of the demand for 
more of it becomes clearly apparent. It is an insult 
to the intelligent people of our land to believe that they 
can accept and maintain a doctrine that more money 
creates more goods. As well try to persuade them that 
the more shoe-strings they have the more shoes they 
own. Stupid legislation on money has done incalculable 
harm. It brought us the panic of 1893. When the 
chicken-hawk of monetary idiocy appears in the sky,< 
the shy chickens of capital and industry scurry to cover. 
In this connection it may be well to point to one of the 
most important of all the recommendations in Mr. Car- 
lisle's message. It was tucked away in the end of an 
innocent-looking sentence of the President's message, 
but was more fully developed by the secretary himself. 



ELASTICITY OF BANK-ISSUES 35 

He advocated the abolition of fixed reserves for deposits. 
This, with the proposal to withdraw the greenbacks, 
was the most refreshing talk we had had for years. To 
abolish the fixed reserve might help more to aid bor- 
rowers in a panic than to make note-issues elastic. It 
touched the vital relations between the three items of 
most importance in a bank-account — the loans, the de- 
posit-liability, and the reserves. It helped to allow the 
bank to discount at the most critical time. As our laws 
then stood (1894), they aided in the ruin of the hard- 
pressed borrower, although he could offer good collateral; 
at the very moment of greatest need they forbade the 
bank to loan at the risk of losing its charter. At the 
very time when loans were most needed and reserves 
were at the legal minimum, banks were forced to cease 
discounting. If this change should be adopted, how- 
ever, there should go with it the repeal of State laws 
limiting the rates of discount. 

Nothing in the proposals for currency reform is more 
commendable than the proposal to retire the United 
States notes. The government in its struggle to main- 
tain our standard by selling bonds furnished a lesson 
which should not pass unheeded. The whole matter 
was undignified and unsafe. Why should the whole 
business of the country wait on the fluctuating politics 
of a Congress chosen, as a rule, not for financial experi- 
ence, but for political prowess? 

The government should not issue notes, for many 
reasons: First, because no government can determine 
the amount of issues which would satisfy business, and 
which should be automatic; second, because there is 
no self-interest to prevent overissues and maintain con- 
vertibility (as in our Civil War); third, because it may 
any hour bring us all the evils in the train of depreciated 



36 BANKING PROGRESS 

paper, speculation, inflation, thirst for "more money," 
increase of government burdens, and overwhelming diffi- 
culties in returning to solvency again by contraction; 
fourth, because government issues are inelastic; and, 
fifth, because it puts the government in the dangerous 
position of trying to influence and control prices and the 
money markets. These are reasons enough for the with- 
drawal of the United States notes. But there should be 
no complex schemes for withdrawing them. Let them 
be funded in low-interest-bearing bonds. 1 

§ 7. The movement urging on the Baltimore Plan 
was soon merged in the general activity of business men 
which led to the Indianapolis Convention of January 12, 
1897, and the appointment of the Monetary Commission 
of the same year. The outcome of that commission ap- 
peared directly in the act of March 14, 1900, chiefly con- 
cerned with the maintenance of the gold standard (as ex- 
plained already in Chapter I). But its recommendations 
for the gradual withdrawal of the greenbacks, in connec- 
tion with a revision of the issues by the banks, were not 
carried out. Although this act chronologically came after 
the proposals of the Baltimore Plan, it comes first in the 
evolution of thinking on money and banking and, there- 
fore, is first disposed of in this volume. 

The work of this commission, however, was directly 
concerned with a study of our banking system, the in- 
elasticity of its issues, and it advocated at length in its 
final report (1898) measures aiming to substitute com- 

ir The main arguments presented against the Baltimore Plan were that it 
gave to the banks the power and right to create money; that this power be- 
longed solely to the government, and that the banks would thereby be allowed 
to make money scarce or plentiful to their own gain. On this general argu- 
ment see Laughlin, Money and Prices, chap. X, "Government vs. Bank 



ELASTICITY OF BANK-ISSUES 37 

mercial paper for government bonds as security for 
bank-notes. The material presented in that report was 
widely studied and had no little influence on the think- 
ing of that time. Its proposals were at first more or 
less unfamiliar to the public, and even to the rank and 
file of the banking profession, and yet in ten years its 
recommendations were practically all incorporated in the 
bill of the American Bankers' Association in 1908 and 
presented to Congress in that year. 



CHAPTER ni 

INFLUENCE OF THE PANIC OF 1907 

§ 1. The intention in this chapter is not to give a 
general history of the panic of 1907, but only to show 
how the panic affected the evolution of thinking on bank- 
ing and how the groping through the matters affecting 
notes and media of exchange led to the underlying prob- 
lems of the organization of credit. 

The inelasticity of our forms of money had by this 
time become a trite subject; but the conditions of the 
money market, which in the crisis of 1907 led to a general 
resort to clearing-house certificates throughout the coun- 
try, brought a new interest in measures of reform. Ob- 
viously, a strong impetus was given to the discussion of 
an emergency issue by the national banks, and there 
was an evident determination to secure currency legisla- 
tion from the next session of Congress. 

As every one knew, our greenbacks (United States 
notes) and our silver circulation were fixed at a rigid 
limit, which could be neither increased nor diminished. 
The national bank notes were, also, inelastic, for all 
practical purposes. Therefore, of all our varied forms 
of lawful money, only gold was truly elastic. If we had 
too much we could send it to the arts, or ship it abroad; 
if we had too little, we could import from any market 
in the world on which we had credits. Finally, as had 
been displayed during the panic in an impressive manner, 
the only "currency" which is really elastic in e\ery 
sense, and the only one to be resorted to when every other 
medium of exchange is unavailable, is the deposit-cur- 



INFLUENCE OF THE PANIC OF 1907 39 

rency (checks drawn on deposits). While clearing-house 
certificates are in use only between banks, checks have 
become the general and efficient currency with which 
merchants meet their engagements both with individuals 
and the banks. If a borrower can get a loan, he can meet 
his maturing obligations effectively by the use of checks. 
In a crisis, therefore, the one important thing is getting 
the loan, and getting it in the form of a means of pay- 
ment which his creditor will accept. 

Yet, borrowers may in some cases require notes which 
can be used in paying wages, and in meeting the needs 
of retail trade, expenses of travel, and the like. In a 
crisis like that of 1907 this kind of a demand for money 
might have been adequately met by the issue of bank- 
notes; and the amount of lawful money in the pockets 
of the people might have been replaced safely by such 
notes. When frightened depositors drew and hoarded 
money, it was usually taken from lawful money reserves, 
and reduced the immediate power of the bank to lend 
under certain conditions by at least four times the sum 
of the withdrawals. Therefore, if those depositors could 
have been induced to accept bank-notes, instead of law- 
ful money (gold and gold certificates, silver and silver 
certificates, greenbacks, and treasury notes of 1890), 
there would have been at hand a means of quieting the 
public alarm, and of preventing what was practically a 
general suspension of cash payments. To this extent the 
issue of an emergency circulation by the national banks 
would have had a salutary influence. There was here a 
field for bank-notes of unmistakable importance, which 
justified all the arguments in favor of new legislation, 
such as was proposed by the Fowler Bill, or by that of 
the American Bankers' Association. 

A period of panic invariably enforced the necessity of 



40 BANKING PROGRESS 

some marginal elasticity on the total circulation. In- 
ability to obtain circulating notes for cash payments 
necessarily intensified the unfortunate conditions inci- 
dent to a collapse of credit. In the summer of 1893 it 
was practically impossible to obtain a sufficient supply 
of a circulating medium of any kind. On June 1, 1893, 
the banks of New York held $21,000,000 in excess of 
their legal cash reserves. The national bank notes then 
outstanding were about $177,000,000. The exceptional 
demands for currency had drawn down the reserves of 
the New York banks, by August 1, $14,000,000 below 
the legal minimum. Yet the total of the national bank 
notes outstanding at that date had risen by only $5,000,- 
000. By September 1, when the emergency had passed 
and currency was once more relatively abundant, the 
national bank notes had expanded to $199,800,000, and 
later rose by November 1 to $209,300,000. 

The experience in the panic of 1907 was confirmatory. 
Then, the height of the crisis came in October. Every 
possible effort was made to increase the bank-note cir- 
culation, but to little effect. So scarce was currency 
that the clearing-houses in some cities issued certifi- 
cates of small denominations to circulate as money in 
the hands of the public. On July 1 the circulation of 
the national banks was $603,788,690, but by October 31 
it was only $609,980,466; while during November it 
had risen to $656,218,196, and by December 31 to $690,- 
130,894. The bulk of this increase came too late to re- 
lieve the currency stringency. Furthermore, in the fol- 
lowing months, when the clearings showed a decrease of 
over 28 per cent, and when the circulation should have 
declined correspondingly, the national bank notes actu- 
ally increased by about $8,000,000. There was no elas- 
ticity by contraction when the need had passed by. 



INFLUENCE OF THE PANIC OF 1907 41 

It resulted, also, from the panic of 1907 that a more 
liberal policy was introduced by the Treasury in regard 
to the deposit of bonds as security for public funds. It 
was found that nearly all the available government 
bonds had been deposited with the Treasury either to 
secure national bank notes, or deposits of public funds. 
This led to a release by the Treasury of government 
bonds behind public deposits with the banks, in order 
that more bonds could be used to secure bank-notes. 
Previously the Treasury had begun to accept other than 
government bonds as security for deposits. 1 Thus the 
public mind was gradually being prepared to think of 
other than government bonds as a safe security even 
for national bank notes. 

§ 2. The public, however, seemed to be looking for 
more than this from coming legislation; to ask for an 
elastic currency, seasonal elasticity for crop movements, 
was not the only thing needed. It was hoped that 
a new currency law would give the means of averting 
the difficulties of a commercial crisis; but it is well to 
make clear that such a hope, if based solely on note- 
issues, was wholly elusive. There was more than one 
element in the situation which was then beyond the 
influence of legislation, present or future. In the first 
place, there was general agreement that the high rates 
of interest of that time, not only in the United States 
but in Europe, were due to a relative scarcity of capital. 
The prodigious development of our resources, and the 
expansion of opportunities for the use of capital here, 
had accompanied a more or less corresponding growth in 

1 In the act of March 4, 1907, sec. 3, it was said: "The Secretary of the 
Treasury shall require the associations thus designated [as depositaries] to give 
satisfactory security, by the deposit of United States bonds and otherwise, 
for the safe-keeping, etc." 



42 BANKING PROGRESS 

Europe. In fact, events had emphasized the truth, 
which need not be enforced for economic students, that 
interest was primarily paid for capital, not for "money." 
If our banks had had abundant capital then, they would 
have had no difficulty whatever because of any lack of a 
medium of exchange in passing it over to railways, or to 
merchants, who wished to borrow. An entry in a deposit- 
account on which a check could be drawn would alone 
have served the purpose. In truth, there was no " scarcity 
of money" for carrying on exchanges other than those 
occasioned by the demands of pay-rolls, retail trade, and 
the like. The great need was for a loan; and the only 
real scarcity, so far as it concerned money, could have 
been only in the kind which was available for lawful re- 
serves, and which affected the immediate ability of a 
bank to lend. In fact, there was no scarcity of gold 
in the world with which reserves could be increased; 
for the burden of recent discussions on gold has been an 
emphasis on the vast new production in increasing the 
level of prices. In short, the scarcity of lawful reserves 
in the banks, or the consequent limitation of loans, could 
have been directly traceable only to a lack of banking 
resources with which to buy enough gold to carry the 
growing burdens of trade, or to the fact that the invest- 
ments of the bank's resources were in assets of a more or 
less speculative quality which could not be realized upon 
in an emergency. Therefore, to the extent that pro- 
motion schemes, or overtrading, formed the basis of 
bank loans we had a case of abnormal credit to deal with. 
The acceptance of questionable collateral is wholly a 
matter of banking judgment and it has nothing what- 
ever to do with abundance or scarcity of money. Even 
if reserves were full, a bad loan would still remain a bad 



INFLUENCE OF THE PANIC OF 1907 43 

loan. It is to be seen, then, that congressional legisla- 
tion could not be expected to remedy any lack of capital, 
or to avert the effects of past mis judgment, or of folly, 
in accepting doubtful collateral. 

It is highly important to disabuse the popular mind 
of the fallacy that the real difficulties of a crisis like that 
of 1907 could be removed by the issue of bank-notes. 
As has been repeatedly said, the crucial need, the one 
need important above all others, was that of obtaining 
a loan to meet maturing obligations or of continuing a 
loan already made. If banks, because collateral shrinks, 
or loans fall due, begin to call in loans, and refuse con- 
tinuations, in order to build up their reserves, general 
liquidation and depression are at hand. The ability to 
lend is the crux of the whole matter; and other things 
are secondary to it. How true this is may be seen by 
the action of the Bank of England in a panic. While 
the act of 1844 has not saved the English from serious 
collapres of credit, its operation has disclosed the real 
source of trouble in the ease or difficulty of getting loans 
at the banking department. This difficulty did not 
primarily reside in a lack of money; nor was the increase 
in the rate of discount the cause of a direct increase in 
the charge for gold at the issue department. The high 
rate of discount affected only loans at the banking de- 
partment, which is entirely independent of the issue 
department. When new loans are made by the former, 
the deposits are increased, and the percentage of reserves 
to deposits is lowered. And it is to be remembered that 
Bank of England notes are permitted in the banking re- 
serves. If, in a crisis, a great pressure for loans devel- 
oped, the bank — above all things — did not refuse to lend, 
even if its reserves were drawn down. Instead, the di- 



44 BANKING PROGRESS 

rectors violated the law 1 at that time forbidding the 
issue of more than about sixteen and three-fourths mil- 
lions of pounds on the security of government bonds; 
took bonds from the assets of the banking department 
to the issue department; got notes on the security of 
these bonds; and thereby replenished the lawful re- 
serves of the banking department. This meant that 
all borrowers with satisfactory collateral could get loans. 
That fact once widely known stopped the rush for loans 
not absolutely imperative; and the alarm subsided. 

The lessons from the previous discussion, as well as 
from the experiences of European banks, must be very 
plain. Nothing could be of any help to us in a crisis 
which did not aid the banks in lending to legitimate bor- 
rowers. Only in so far as assets could be used to obtain 
more lawful money — money which could be added to the 
reserves, and thus increase the power of the banks to re- 
lieve needy borrowers — could mere currency schemes be 
of any great use in a financial crisis. This truth could be 
fully appreciated by observing at that time the purchase 
of foreign gold by use of credits on Europe based on cot- 
ton or grain bills, or on the sale of our cheap securities. 
Here was one direct way of securing our lending power, 
and of supporting our commercial houses which needed 
an extension of loans; since changing assets into gold 
directly touched their immediate power to lend. The 
extraordinary decline of lawful reserves in the New York 
banks for the week ending November 9, 1907, to $51,- 
000,000 below the legal limit, coupled with a large in- 
crease of loans, showed that the banks were doing the 

1 The power to disregard the limit fixed by the act of 1844 was on August 
6, 1914, delegated to the Treasury; and the minimum of notes secured by 
bonds has risen to £18% millions. For the working of this system in the 
unequalled panic of 1914, on the outbreak of the European War, see Laughlin, 
Credit of the Nations, chap. III. 



INFLUENCE OF THE PANIC OF 1907 45 

only wise thing — making necessary loans — and yet liber- 
ally furnishing actual cash to other parts of the country 
out of their reserves. The only question was whether 
the imports of foreign gold would overtake the with- 
drawals from the reserves. 

The only other direct means, under the law of that 
day, was to collect greenbacks, silver, and treasury notes 
of 1890. The last had been almost eliminated; and the 
former two were rigidly fixed in amount. But, we heard 
on every side of a demand for more bank-notes. Would 
the issue of their own bank-notes, their demand-liabili- 
ties, increase the ability of the banks to lend? Evi- 
dently not. These notes could not be used in their re- 
serves; nor should they ever be so allowed. In short, 
apart from protecting reserves from a drain, an elastic 
bank currency could not directly avert the essential diffi- 
culties of the situation. The supposed elasticity in a 
financial crisis was not, as is usually thought, a matter 
merely of more "money." 

§ 3. In this connection, the plan of the American 
Bankers' Association 1 and that of the Fowler Bill should 
not be overlooked. These plans were on some points 
practically identical, and contained the following pro- 
visions: 

1. Any national bank having been actively doing business 
for one year and having a surplus fund equal to 20 per cent of 
its capital shall have authority to issue credit notes as follows, 
subject to the rules and regulations to be fixed by the comp- 
troller of the currency: 

(a) An amount equal to 40 per cent of its bond-secured cir- 
culation, subject to a tax of 2}^ per cent (3 per cent in the Fowler 
Bill) per annum upon the average amount outstanding. 

1 See infra, Appendix I. 



46 BANKING PROGRESS 

(b) A further amount equal to l%}4 per cent of its capital, 
subject to a tax at the rate of 5 per cent per annum upon the 
average amount outstanding in excess of the amount first 
mentioned. 

2. The same reserves shall be carried against credit notes 
as are now required by law to be carried against deposits. 

8. A 5 per cent guaranty fund for the redemption of the 
notes of a defaulting bank. 

4. Numerous redemption offices in various parts of the 
country, to secure easy and quick redemption when desired. 

5. The repeal or the modification of the act of July 12, 1882, 
limiting the withdrawal of notes to $3,000,000 in any one month. 

It will be observed from these provisions (1) that the 
emergency circulation, in the issue of at least the first 
40 per cent, was contingent upon the bank's previous 
issue of notes secured by government bonds. When we 
remember that the largest city banks had, as a rule, 
made little or no use of their right to issue notes, and 
that they had done their enormous business, earned 
their profits, and built up their huge surpluses, solely 
by the use of the deposit-currency, we shall see that 
were such legislation obtained the great banks of New 
York and other cities would not have been able in such a 
crisis as that of 1907 to issue any emergency notes to 
speak of. 

Again, it is to be noted (2) that the same reserves of 
lawful money were to be maintained behind these emer- 
gency notes as behind ordinary demand-deposits. If 
this were enacted, and if there were a great pressure for 
loans from the business public, a bank would be just as 
much inhibited from granting a loan in the form of its 
notes as in the form of its deposits. In the case of any 
drain on its lawful reserves, it would be checked from 
lending in either form. The privilege to issue emer- 
gency notes would not, under such a law, aid the banks 



INFLUENCE OF THE PANIC OF 1907 47 

in lending to legitimate borrowers, and therefore in 
averting the disasters due to weakened confidence, a run 
on cash reserves, or eventual liquidation. In short, so- 
called currency evils were not responsible for the crisis; 
nor would the legislation here proposed have met the 
essential needs created in a serious financial stringency. 
To have allowed the banks to increase their own evi- 
dences of debt would not have increased their reserves 
of lawful money, or their ability to lend. 

§ 4. This examination of the proposed reforms of our 
currency ought not, however, to be regarded as an argu- 
ment against the desirability of other and more advanced 
legislation. The reasons for wishing an elastic bank 
currency are good and sufficient in themselves; but they 
must not be used for supporting emergency notes as a 
real cure for the evils of such a financial crisis as that of 
1907. In justice it should be repeated, on the other 
hand, that a quick issue of bank-notes during a time of 
threatened danger would be a great help in warding off 
assaults on the lawful reserves. Whenever depositors 
call for "money," and payments are made in the bank's 
own notes, for a time the public would be satisfied, and 
the lawful money reserves would be kept intact. Thus, 
the right to issue emergency notes would be a very use- 
ful device in protecting for a time the lawful reserves 
from depletion; and in a stringency of no great severity, 
the amount of such notes would prevent the evils of ab- 
normal credit from doing much injury. 

It was observed by Mr. Fowler that an enormous 
amount of lawful money was out in the hands of the 
people, which, if in the reserves of the banks, would be- 
yond all question increase the power of the banks to lend. 
It is to be noted, however, that increased loans should 



48 BANKING PROGRESS 

go with an increase of sound assets rather than with a 
mere enlargement of reserves. Obviously, the banks 
ought — under proper safeguards — to be allowed to issue 
notes in such denominations, and in such amounts as the 
public want them. That proposition would bring in, 
however, many important considerations, one of which 
was the treatment of our silver circulation. The act of 
1900 particularly provided means by which the large sil- 
ver certificates should be replaced by small denomina- 
tions so as to secure their being kept out in the hands of 
the public. Hence, if it be argued — and there was a 
good ground for the argument — that the silver circula- 
tion should be displaced by small bank-notes, then the 
reform of our currency necessarily included the various 
forms of silver money. This made it clear that any- 
thing but a monetary pis alter should deal with more 
than our bank-note issue. Indeed, sooner or later, we 
had to face the larger questions in our currency short- 
comings due to other than bank-issues. That 1908 was 
not the psychological hour for a real reform was later 
clearly seen. 

If we were capable, in this country, of intelligently 
facing the problem of creating an efficient method of 
meeting, or mitigating, the inevitable dangers of a finan- 
cial crisis, it was evident as early as 1908 that we should 
establish some institution wholly free from politics, or 
outside influence — as much respected for character and 
integrity as the supreme court — which would be able, 
in a great emergency, to use government bonds or selected 
assets as a basis for the issue of forms of lawful money 
which could be added to the reserves of the banks. 
Nothing else than this would meet the imperative need 
of loans. Bank-notes are not a legal tender between 
private persons; and could not be made into lawful re- 



INFLUENCE OF THE PANIC OF 1907 49 

serves for the very issuers of the notes. It is doubtful 
if a great central bank — apart from its political impossi- 
bility — would accomplish the desired end. It is con- 
ceivable, however, that a commission (or board) of a 
high order, appointment to which would be a great honor, 
might, under general legislation, be competent to do for 
the United States what in effect the governor and direc- 
tors of the Bank of England do for the English money 
market, when they create additions, under the advice 
and consent of the government, to the lawful reserves of 
the banking department. 1 

1 This idea, expressed in 1907, was eventually embodied in the present Federal 
Reserve Board. 



CHAPTER IV 

THE ALDRICH-VREELAND ACT 

§ 1. Although the Monetary Commission Bill of 
1898 1 was advisedly intended to be a transition measure, 
retaining as a compromise a partial bond feature, the re- 
port presenting it had been leavening public opinion for 
many years. That presentation brought the subject be- 
fore bankers and legislators for practical consideration. 
It will be interesting to watch how far it has colored suc- 
ceeding legislation. As already said, the bill drawn up 
by the Currency Commission of the American Bankers' 
Association 2 in the early part of 1908 contained all the 
important provisions of the earlier bill. Likewise, the 
bills introduced at this time by Mr. Fowler, chairman of 
the House Banking Committee, although differing from 
the other plans in simplicity and in the means for carry- 
ing out the change from the old to the new system, were 
founded on the same general principles. Finally, the 
panic of 1907, as already explained in the preceding 
chapter, pricked public feeling into a demand for addi- 
tional legislation on banking; and the politicians became 
firmly convinced, especially in view of the coming presi- 
dential campaign of 1908, that this public opinion must 
be satisfied by some kind of legislation. The conse- 
quence was the Aldrich-Vreeland Act (H. R. 21871) of 
May 30, 1908. It is a curious compound of conflicting 
views, compromise, haste, and politics; but it became 

1 See Report of the Monetary Commission (1898), pp. 60-74. 

2 See Appendix I. 

50 



THE ALDRICH-VREELAND ACT 51 

the law of the land, and its provisions ought to be sub- 
mitted to careful scrutiny. 

The political considerations affecting the passage of 
the act are not all clearly explicable. The Republicans 
had played fast and loose with the money question in 
the past; and the Democrats had lost prestige, and two 
campaigns, by taking up silver. Neither party had been 
consistent. In early days, the Democratic party — as in 
the time of Benton and Jackson — advocated the gold 
standard and opposed a great central bank; but it forced 
the extinction of the Second United States Bank largely 
because it had tried to exact redemption for the State bank 
issues in the South and West. At the close of the Civil 
War the Democrats took up with the greenback craze, 
thus allowing their opponents to appeal to the business 
public as the champions of sound money. The Repub- 
licans passed the act of 1869 strengthening the public 
credit, passed the Resumption Act of 1875, and resumed 
specie payments, January 1, 1879. The victory over 
greenbackism and inflation was not an easy one; and 
when the Democrats introduced the silver mania as a 
substitute for greenbackism the Republicans wavered. 
The protectionists bought their legislation by votes for 
silver; and Republicans helped to pass the Bland- 
Allison Act of 1878. Moreover, they were chiefly re- 
sponsible for the Sherman Act of 1890, which was fol- 
lowed by a panic and the repeal of silver purchases in 
1893. 

It was this departure of the Republican party from 
sound monetary policy — on the ground of expediency in 
catching votes — which gave the opportunity to the 
Democrats under the leadership of President Cleveland 
to outgeneral their opponents. By a stroke of political 
genius Cleveland manoeuvred the Democrats into the 



52 BANKING PROGRESS 

position of advantage formerly occupied by the Repub- 
licans, and restored to them their ancient advocacy of 
the gold standard. Then, for the first and only time since 
the Civil War, did the Democrats elect their candidate 
for President. Immediately thereafter a populistic wave 
overwhelmed the Democrats and carried them off under 
Bryan to the desert of silver and bank hostility. Their 
opposition to the gold standard, and their ignorant atti- 
tude on banking legislation, lost them the confidence of 
the electorate. 

The Republicans, however, went right only by acci- 
dent and expediency. The errors of their opponents 
showed them the pitfalls to avoid; but it was not an 
understanding of the monetary question nor a patriotic 
desire to give the business and industrial interests of our 
land a banking system best adapted to further domestic 
and international trade which actuated the policy of 
the Republicans. They had been on the fence; and they 
finally got down on the gold side only because they saw 
the Democrats struggling in the brambles on the silver 
side. They deliberately used the money question as a 
means of retaining political power and for years kept the 
business interests of the country on tenter-hooks for the 
sake of party advantage. It was not the favor of the 
business public, but the populism and wildness of the 
Democrats on money, which kept the Republicans in 
power. In 1900 the latter were unwilling fully to estab- 
lish the gold standard in the act of March 14, 1900, by 
making our silver coins redeemable in gold, because they 
believed there was still a chance of preventing the dis- 
cussion of the tariff, and retaining public support, by 
keeping the money issue open. This is an illustration 
of the price that industry pays to politics in a democracy. 

Then, when the panic of 1907 forced the temporary 



THE ALDRICH-VREELAND ACT 53 

suspension of payments by banks from the Atlantic to 
the Pacific, and brought on an issue of clearing-house 
certificates and clearing-house currency in default of 
ordinary forms of money, the party in power felt that 
the unthinking voters would charge it with the respon- 
sibility for not having legislated in favor of an abundant 
circulation. The theory on which the supposed demand 
for legislation was based was that the panic was due to a 
scarcity of money. Of course, this specious reasoning 
was nothing more or less than the old argument of the 
greenbackers and the silverites. Yet with the politi- 
cians the point was not whether the theory was right or 
wrong; it was whether or not the theory was actually 
held by masses of voters who were to be cajoled. 

In connection with the measures taken by the Treasury 
to meet the effects of the panic we heard from President 
Roosevelt and the politicians an emphasis upon the sup- 
posed aid which could be rendered by the issue of enor- 
mous sums of currency. Even the sale of Panama bonds 
and 3 per cent certificates was heralded by triumphant 
words of inflation as an addition to the currency. It 
matters little that these securities were not money; it 
was hoped to hoodwink the people. There seemed to be, 
in the matter sent out from Washington to the press, 
little understanding of the causes of the panic; in fact, 
the performances of the Treasury were the crudest in our 
monetary history — and that is saying a good deal. Hav- 
ing no policy as to monetary reform beyond that of 
political expediency, it was not to be expected that the 
Republicans would treat banking legislation on its merits. 
Here is the milk in the cocoanut. No legislation is to 
be had solely because an understanding of banking prin- 
ciples directs a specific reform; the political leaders in 
power do not have sufficient courage to do what is really 



54 BANKING PROGRESS 

needed by the commercial public, provided enough whit- 
tlers on store-boxes at the country crossroads have other 
views as to what should be done. 

The Democrats, as usual, took the populistic attitude 
in urging the issue of all notes by the government, and 
the withdrawal from the banks of the right to issue notes. 
Thereby, they fortunately gave the Republicans a politi- 
cal reason for favoring some legitimate or possible basis 
for the issue of notes by the banks. The question was: 
What basis should the Republicans adopt? That was 
the crux of the Aldrich-Vreeland Bill. 

§ 2. In the session of Congress following the panic of 
1907 the argument for new legislation contained the crude 
expectation that the law would prevent the possibility 
of future panics. This view was expressed both in a 
part of the press and in Congress, and showed little ap- 
preciation of the real causes at work in an inflation of 
credit. In the Senate, where the members of the Finance 
Committee, under the leadership of Senator Aldrich, 
were also the practical rulers of the Republican party, 
a stern opposition was early expressed against any form 
of "asset-currency," and this policy had the support 
of the President. Evidently, the Republican politicians 
believed that the issue of notes by banks on other secur- 
ity than bonds would expose their party to attacks in 
the next campaign which they, in their general incapacity 
on banking questions, would not be able to meet success- 
fully. They could not see that elasticity, ready expan- 
sion of the currency in time of need, and lower rates of 
interest to borrowers might be popular issues with the 
people in any campaign. 

Also, no doubt, there was a conviction in the minds of 
many senators that "asset-currency" was synonymous 



THE ALDRICH-VREELAND ACT 55 

with "wildcat currency" and involved the dangers of 
uncontrollable abuses by excessive issues. It is need- 
less to say that those dangers do not inhere in any legit- 
imate system of "asset-currency," as was amply proved 
by its use in the chief commercial countries of Europe; 
but it is interesting to note that leaders — ignorant of 
banking and openly flouting the advice of trained bankers 
— produced in the Senate Aldrich Bill a plan for notes 
issued on bonds of a kind as like those of "wildcat 
currency" days as any tvvo peas. Looking at the matter 
solely as politics, it is difficult to understand why the 
Senate stubbornly thought it possible to gain votes by 
antagonizing the very commercial bodies and banking 
interests who were most competent to judge of such mat- 
ters. It is a matter of curious interest to know why 
there was political capital to be gained from urging a 
bond-secured system of note-issues which had long been 
known to have been outgrown, rigid, inelastic, hurtful 
to country districts, and of little advantage to large city 
banks which make comparatively small use of the issue- 
function. The bond-secured system lent itself to such 
easy and popular attacks that, as a political move, it 
proved a great blunder. When the Aldrich Bill came 
down from the Senate it was thoroughly riddled in the 
House by the representatives of industry and banking 
who appeared before the Banking Committee; and in 
the House, which much more nearly represented the opin- 
ions of the public than the Senate, it was overwhelmingly 
defeated. One can scarcely avoid the conclusion that 
the Aldrich Bill represented only the stolid personal 
prejudices of a very few mistaken politicians who held 
the reins of power. 

On January 7, 1908, Mr. Aldrich introduced his bill 
(S. 3023), and it was reported out by the Committee on 



56 BANKING PROGRESS 

Finance with amendments, January 30, 1908. Later, be- 
fore passing the Senate, some radical amendments were 
added, to meet the views of such men as Senator LaFol- 
lette (e. g., sec. 11). The original Aldrich Bill permitted 
a national bank, having an outstanding circulation se- 
cured by United States bonds to an amount not less than 
50 per cent of its capital, and which had a surplus of 20 
per cent, to issue additional circulation secured by bonds 
other than bonds of the United States. These other bonds 
were as follows: 

Bonds or other interest-bearing obligations of any State of 
the United States, or any legally authorized bonds issued by 
any city, town, county, or other legally constituted munici- 
pality or district in the United States which has been in ex- 
istence for a period of ten years, and which for a period of 
ten years previous to such deposit has not defaulted in the pay- 
ment of any part of either principal or interest of any funded 
debt authorized to be contracted by it, and whose net funded 
indebtedness does not exceed ten per centum of the valuation 
of its taxable property, to be ascertained by the last preceding 
valuation of property for the assessment of taxes; or the first 
mortgage bonds of any railway company, which, in compliance 
with existing law, reports regularly to the Interstate Commerce 
Commission a statement of its condition and earnings, and 
which has paid dividends of not less than four per centum per 
annum regularly and continuously on its entire capital stock 
for a period of not less than five years previous to the deposit 
of bonds. 

Notes secured by other than United States bonds could 
be issued on the approval of the secretary of the treasury 
to an amount, if by railway bonds, equal to 75 per cent, 
and if by other bonds, to 90 per cent of their market 
value. The limit of notes issued by a bank was the 
amount of its capital and surplus; and the total of this 
additional circulation issued by all the banks was to be 



THE ALDRICH-VREELAND ACT 57 

$500,000,000. To allow contraction, United States bonds 
could be withdrawn by the deposit of lawful money; 
other than United States bonds, by the deposit of lawful 
money or national bank notes. The notes were to carry 
on their face a pledge of the United States that they would 
be redeemed on presentation in lawful money. A tax 
of 3^ of 1 per cent was levied on the notes, if secured by 
United States bonds bearing less than 2 per cent interest; 
1 per cent, if the United States bonds bore more than 2 
per cent; and 1 per cent, if the bonds were other than 
United States bonds. The Aldrich Bill was amended so 
as to include the bonds of Porto Rico and the Philippine 
Islands, but to exclude American railway bonds. It 
passed the Senate (March 27) and was referred in the 
House to the Committee on Banking and Currency, 
March 30, 1908. 

As opposed to this Senate measure was the Fowler 
Bill, reported from the Banking Committee to the House. 
The original Fowler Bill (H. R. 23017, Fifty-ninth Con- 
gress, Second Session) introduced December 20, 1906, 
in the main had the support of the bankers. This bill 
followed the general plan of the Monetary Commission 
of 18P8, but proposed a gradual change from notes se- 
cured by United States bonds to notes secured by com- 
mercial assets. According to it, "National Bank Guar- 
anteed Credit Notes," equal to 40 per cent of the notes 
issued by a bank secured by United States bonds, and not 
exceeding 25 per cent of its capital, could be issued with- 
out the deposit of any United States or other bonds. 
Such notes to pay a tax of 3 per cent. An additional 
amount of notes equal to 12J/£ per cent of the capital 
could be issued by paying a tax of 5 per cent. The out- 
side limit was the amount of the capital. The holder of 
these credit notes was to be a general creditor of the 



58 BANKING PROGRESS 

issuing bank. A guaranty fund of 5 per cent of the credit 
notes was established, and all taxes on circulation were 
to be covered into this fund. Additional redemption 
cities were required. 

In the next session of Congress (Sixtieth Congress, 
First Session) Mr. Fowler introduced another bill (H. R. 
12677), January 8, 1908, and it was reported out by the 
Committee on Banking and Currency, February 29, 1908. 
In this later bill Mr. Fowler seemed to have lost the sup- 
port of the American Bankers' Association; and, of 
course, the administration and the leaders in Congress 
who favored a bond-secured circulation opposed it. 
His measure went to extremes, and included many other 
than banking schemes. While some of the additions, 
excepting the guaranty of deposits, were meritorious, 
Congress and the public wished to act on only one thing 
at a time. This bill (H. R. 12677) urged the creation of 
not more than twenty bank redemption districts, con- 
trolled by eight managers and a deputy comptroller, and 
within which each bank should select a redemption centre 
for its notes. Its refusal of all compromise appeared in 
its allowing a bank at once to retire all its notes secured 
by United States bonds and replace them with notes, 
not secured by bonds of any kind, to a limit equal to its 
capital; provided the bank had arranged for the redemp- 
tion of its notes in gold at a redemption centre, and had 
deposited with the Treasury in gold, or lawful money, 5 
per cent of its notes, and 5 per cent of its deposits, as 
guaranty funds. If the district managers approved, a 
bank might issue an additional amount of notes equal to 
100 per cent of its capital. Such notes would have a 
distinctive color, and state on their face that they were 
redeemable in coin and guaranteed by a fund deposited 
with the Treasury. After January 1, 1909, no notes se- 



THE ALDRICH-VREELAND ACT 59 

cured by bonds were to be paid out. Banks were to pay 
2 per cent interest on government deposits, and to be 
freed from giving bonds as security for deposits. The 
notes to be taxed 1 per cent. In addition the measure 
contained provisions for a guaranty of deposits, for 
enabling national banks to do a trust business, for abol- 
ishing the independent treasury system, and for the even- 
tual retirement of the greenbacks. 

It soon became evident that, while the House would 
pass a bill permitting a trial of commercial assets as a 
basis for note-issues, it was not ready to throw over all 
bond security; and also that the House would not pass 
the Aldrich Bill. Hence, both the Aldrich and the 
Fowler Bills were impossible. Yet the political managers 
were firm in the belief that some banking bill was obliga- 
tory in view of the recent panic. A caucus of the Re- 
publican party in the House appointed a committee, in- 
cluding Mr. Vreeland (New York) and Mr. Burton 
(Ohio) but excluding Mr. Fowler, the chairman of the 
Banking Committee, to frame the bill. Mr. Fowler had 
incurred the hostility of the administration and of the 
leaders of the House and Senate, and was officially ig- 
nored. This caucus bill, not being based on any purpose 
to touch the real merits of the problem, was wrung from 
the politicians by force of events. 

Two bills (H. R. 21810 and H. R. 21871) were intro- 
duced by Mr. Vreeland on May 11 and May 12, 1908. 
They differed only in slight matters, except that the later 
bill changed the words to be printed on the notes. Re- 
demption by the United States was dropped out, and the 
words of the act as finally enacted were introduced. 
Knowing this measure to be inspired by those who had 
the power to enact it, its provisions were of importance: 
National clearing-house associations, made up of not less 



60 BANKING PROGRESS 

than ten banks having an aggregate capital and surplus 
of at least $5,000,000 were created, to be managed by a 
board having one representative from each bank and 
given the power to issue additional notes based on "any 
securities, including commercial paper, held by a national 
banking association," provided the given bank already 
had outstanding notes secured by United States bonds 
to an amount not less than 40 per cent of its capital. 
Notes were hmited to 75 per cent of the cash value of the 
securities, or of the commercial paper. These notes 
were a lien on all the assets of all the banks in the given 
currency association issuing the notes. The limit of the 
issues of any one bank was its capital and surplus; and 
the aggregate of the additional issues (not based on 
United States bonds) was $500,000,000. Banks must 
hold the same reserves behind the emergency circulation 
as for deposits; notes secured by 2 per cent United States 
bonds to pay a tax of J^ of 1 per cent; if bearing more 
than 2 per cent, a tax of 1 per cent; if secured through 
clearing-house associations (*. e. 9 on commercial paper, 
etc.), a tax of 4 per cent, increasing monthly by 1 per 
cent, until 10 per cent was reached; these taxes to be 
covered into the general funds of the Treasury. Notes 
secured by United States bonds could be withdrawn at 
a rate not exceeding $9,000,000 a month; if otherwise 
secured, no such limit was imposed. The directions as 
to the wording on the notes were as follows: 

Such notes shall state upon their face that they are secured 
by United States bonds or other securities according to law, 
shall be certified by the written or engraved signatures of the 
Treasurer and Register, and by the imprint of the seal of the 
Treasury. They shall also express upon their face the promise 
of the banking association receiving the same to pay on de- 
mand, etc. 



THE ALDRICH-VREELAND ACT 61 

Whenever these notes were presented to the Treasury for 
redemption, they should be redeemed in lawful money. 
Finally, a National Currency Commission was to be ap- 
pointed, having six senators, six representatives, and six 
others, to investigate "the causes of the recent financial 
crisis," and to make recommendations in a report by 
January 1, 1909. It is worth noting that in the final 
enactment the commission was relieved from explaining 
the causes of the panic. 

Mr. Fowler, not to be repressed, introduced his bill 
again, May 4, 1908, shorn of its extreme provisions. 
Accepting a requirement that a bank should already 
have notes outstanding secured by United States bonds 
equal to 50 per cent of its capital, it could then issue 50 
per cent more not secured by bonds; and in an emer- 
gency an additional sum equal to 100 per cent of its cap- 
ital and surplus, with the consent of district managers 
and the comptroller. On January 1, 1909, however, all 
notes secured by United States bonds were to be cancelled. 
The provisions for guaranty of deposits, trust business, 
abolition of the greenbacks and the subtreasury were 
dropped. 

This bill, favored by many, was rudely set aside and 
the Vreeland Caucus Bill was passed in the House by a 
large majority. The Senate refused to accept it, the 
Aldrich Bill was substituted, and the matter was finally 
referred to a conference committee of both Houses. 
After considerable struggle in conference, in which much 
of the Aldrich Bill was introduced into the Vreeland Bill, 
the Aldrich-Vreeland Bill was reported to both Houses 
in the last days of the session, and hurriedly passed under 
the party lash, May 30, 1908. It was passed before 
printed copies of the bill were distributed. 

Like most political measures, which look both ways 



62 BANKING PROGRESS 

and try to conciliate conflicting interests, the Aldrich- 
Vreeland Act contained many inconsistencies. On the 
one hand, it catered to a supposed public opinion among 
the masses against "asset-currency"; and on the other 
hand, it aimed to win the eager support of the influential 
classes owning or marketing the great volume of financial 
securities. By inserting much of the Aldrich Bill into 
the Vreeland Bill in the Conference Committee, the bond 
interests evidently won a great victory. Nevertheless, 
in view of the evident desire to play politics and win the 
most votes, it is almost inconceivable that the exceptional 
favors to holders of market securities should have been 
regarded as good politics, especially as the measure at 
the same time alienated large banking and commercial 
interests. 

§ 3. This Aldrich-Vreeland Act, emerging from such 
political conditions, was entered on the statute-books. 
It is therefore important as a part of our banking history 
to know just what its provisions were. It is evident, 
from the start, that the haste with which it was pushed 
through Congress must have made careful legislation 
impossible. In some quarters 1 it was heralded as a great 
triumph of Republican monetary policy; and in other 
quarters it was regarded as bad in theory, and a cheat, 
because it was offered as a compromise to asset-currency 
advocates in a form greatly minimizing what it was said 
to offer. Certainly the law was a failure, if it was ex- 
pected to quiet the urgent demand for real banking re- 
form; and the political gains were far to seek. 

One evident purpose of the law was to remove in the 
future the inability of the banks to increase their note- 

1 Theodore Gilman, "The Aldrich-Vreeland Bill," North American Review, 
August, 1908. 



THE ALDRICH-VREELAND ACT 63 

issues in an emergency such as was disclosed in the 
panic of 1907. And it must be admitted that in a mea- 
sure this end was accomplished, although by means which 
proved to be clumsy and not foreseen by the framers of 
the law. The act enabled a bank which had already 
outstanding notes secured by United States bonds to an 
amount equal to 40 per cent of its capital, and which 
had a surplus of 20 per cent, to take out additional cir- 
culation either (1) on certain bonds other than United 
States bonds, or (2) on any securities, including com- 
mercial paper, held by a national banking association. 
In (1) the bank can deal directly as an individual with the 
Treasury. In (2) the bank must act through a national 
currency association created by this law. 

The preliminary requirement that no bank could issue 
additional circulation unless it had already outstanding 
notes secured by United States bonds equal to 40 per 
cent of its capital was one that created serious difficul- 
ties. It was a part of the persistent adherence to a 
bond-secured note-issue; and was supposed to be a mea- 
sure of a transitional character on the way to some new 
basis of security. This provision, however, seemed to 
ignore the character of the business done by the largest 
city banks. In the past their loan and deposit functions 
had been chiefly exercised through checks on deposits, 
and actual notes had been little called for in large transac- 
tions. Possibly the needs of country correspondents 
may have increased somewhat an otherwise small issue 
of notes by banks of the largest size; but only in the 
panic of 1907 had these large banks resorted to any con- 
siderable issue of notes. Therefore, if there should be a 
general desire to put themselves in a position to issue 
additional notes under this new act, the banks, under the 
necessity of first issuing 40 per cent of bond-secured notes, 



64 BANKING PROGRESS 

would certainly greatly increase the demand for United 
States bonds. July 31, 1908, there were deposited to se- 
cure circulating notes United States bonds to the amount 
of $629,432,420; and to secure public deposits, $145,869,- 
372; while the total issue of bonds outstanding (including 
$14,086,500, 3 per cent certificates of indebtedness issued 
November, 1907) June 20, 1908, was $897,503,990. 
There was thus very little leeway for increasing notes se- 
cured by United States bonds, in view of the considerable 
amounts of these bonds held permanently by private in- 
vestors. Now it was for the very reason that these bonds 
were high and scarce — how scarce could well be appre- 
ciated by those who tried to borrow them in the crisis 
of 1907 — that the banking system required overhauling. 
And yet the first effect of the act was to send up the price 
of government bonds, already perhaps 20 points higher 
than they would be but for the demand for them as 
security for bank-notes. It was a serious question whether 
the obstacle of a large previous investment in United 
States bonds would not prevent the hoped-for ease of 
expansion in times of emergency. It would certainly be 
a heavy handicap; and it was one more illustration of 
the failure of the act to meet the real difficulties of the 
existing banking situation. If an emergency were to 
arise, the banks would no doubt be obliged to resort, as 
before, to the issue of clearing-house certificates. 

§ 4. In case a bank had satisfied the requirement as 
regards circulation based on United States bonds, then 
it could (1) secure additional circulation based on other 
than United States bonds, by making application directly 
to the comptroller of the currency, and without the in- 
tervention of any currency association. Notes could be 
issued to the amount of 90 per cent of the market value 



THE ALDRICH-VREELAND ACT 65 

of these bonds, and were limited, all told, to the amount 
of a bank's capital and surplus. The kind of bonds 
allowed was clearly described (sec. 3) as follows: 

Bonds or other interest-bearing obligations of any state of 
the United States, or any legally authorized bonds issued by 
any city, town, county, or other legally constituted munici- 
pality or district in the United States which has been in exist- 
ence for a period of ten years, and which for a period of ten 
years previous to such deposit has not defaulted in the pay- 
ment of any part of either principal or interest of any funded 
debt authorized to be contracted by it, and whose net funded 
indebtedness does not exceed ten per centum of the valuation 
of its taxable property, to be ascertained by the last preceding 
valuation of property for the assessment of taxes. 

But, (%) should a bank wish to make use of its commer- 
cial assets as a basis for its circulation, it must act through 
a national currency association. Such a voluntary asso- 
ciation, modelled somewhat after the plan of a clearing- 
house association, must contain not less than ten banks, 
having an aggregate capital and surplus of at least $5,- 
000,000. To it was given legal corporate powers. Only 
one association could be formed in any one city; and no 
bank could belong to more than one association. The 
banks must be taken from contiguous territory. Any 
duly qualified bank, on application to the secretary, could 
force its entrance into an association, and have all the 
rights of an original member. Thus, banks in New Jersey 
or Connecticut could insist on membership in the asso- 
ciation of New York City, under the literal interpreta- 
tion of "contiguous territory" given by Secretary Cor- 
telyou. An association was governed by a board con- 
sisting of one representative from each bank. Thus a 
bank with a capital of $25,000 had equal influence with 
one having a capital of $25,000,000, and it was discov- 



66 BANKING PROGRESS 

ered that no provision existed in the law by which a bank 
having once entered could ever withdraw from an asso- 
ciation. This evidence of carelessness in drawing up the 
act caused great hesitation and delay in the formation of 
associations. In October, 1908, that in Washington, 
D. C, was the only one formed. 1 Influential banks, held 
jointly liable with small banks for the redemption of 
any notes authorized by the association, were slow to 
enter a combination from which they could not withdraw 
in case of bad management. Once in, a bank could not, 
during the six years of the act, withdraw even in order 
to take out notes as an independent bank dealing directly 
with the comptroller. This awkward situation was cer- 
tain to call out an amendment. 

§ 5. Supposing the difficulties connected with the 
forming of currency associations and the investment in 
United States bonds were surmounted, then we would be 
face to face with the new methods of issuing additional 
notes based on banking paper. The provisions concerned 
with the basis of security were so pivotal, and so likely 
to be differently interpreted, that it is well to quote 
them herewith. Indeed, the greatest surprise of the act 
is probably to be found in the crudeness, or haste, with 
which the law was framed on thes.e points: 

Sec. 1. The national currency association herein provided 
for shall have and exercise any and all powers necessary to carry 
out the purposes of this section, namely, to render available, 
under the direction and control of the Secretary of the Treasury, 
as a basis for additional circulation any securities, including 
commercial paper, held by a national banking association. For 
the purpose of obtaining such additional circulation, any bank 

1 Later, on the urgent request of "Secretary MacVeagh, many associations 
were reluctantly formed. Cf. Chapter VIII, § 1. 



THE ALDMCH-VREELAND ACT 67 

belonging to any national currency association, having cir- 
culating notes outstanding secured by the deposit of bonds 
of the United States to an amount not less than 40 per centum 
of its capital stock, and which has its capital unimpaired and 
a surplus of not less than 20 per centum, may deposit with and 
transfer to the association, in trust for the United States, for 
the purpose hereinafter provided, such of the securities above 
mentioned as may be satisfactory to the board of the association. 
The officers of the association may thereupon, in behalf of such 
bank, make application to the Comptroller of the Currency for 
an issue of additional circulating notes to an amount not ex- 
ceeding 75 per centum of the cash value of the securities or 
commercial paper so deposited. The Comptroller of the Cur- 
rency shall immediately transmit such application to the Secre- 
tary of the Treasury with such recommendation as he thinks 
proper, and if, in the judgment of the Secretary of the Treasury, 
business conditions in the locality demand additional circula- 
tion, and if he be satisfied with the character and value of the 
securities proposed and that a lien in favor of the United States 
on the securities so deposited and on the assets of the banks 
composing the association will be amply sufficient for the pro- 
tection of the United States, he may direct an issue of addi- 
tional circulating notes to the association, on behalf of such 
bank, to an amount in his discretion, not, however, exceeding 
75 per centum of the cash value of the securities so deposited: 
Provided, That upon the deposit of any of the State, city, town, 
county, or other municipal bonds, of a character described in 
section three of this Act, circulating notes may be issued to 
the extent of not exceeding 90 per centum of the market value 
of such bonds so deposited; And provided further, That no na- 
tional banking association shall be authorized in any event to 
issue circulating notes based on commercial paper in excess of 
30 per centum of its unimpaired capital and surplus. The 
term "commercial paper" shall be held to include only notes 
representing actual commercial transactions, which when accepted 
by the association shall bear the names of at least two responsible 
parties and have not exceeding four months to run. 

In these words we have the final outcome of the whole 
struggle between those in favor of securing notes only by 



68 BANKING PROGRESS 

bonds and those in favor of securing them by commer- 
cial assets. If United States bonds were no longer to be 
the sole security, then the system of a bond-secured cir- 
culation was to be retained, but by accepting other than 
United States bonds as a basis. This was the policy of 
the Aldrich Bill. Senator Aldrich opposed absolutely 
any issue of notes based on the current assets of banks, 
and insisted on a bond-secured currency, or nothing. 
Only when the House leaders were unable to pass the 
Aldrich Bill in the House, as already explained; when it 
looked as if the party must go before the country con- 
fessing its impotence to pass any kind of a banking 
law; and only when some recognition of commercial 
assets as security became essential to the passage of a 
bill through the House, did Senator Aldrich reluctantly 
yield. Even then he seemingly intended to restrict the 
use of bank assets within the lowest possible limits. 
Possibly he thought he had allowed only "commercial 
paper," as specifically defined in the act, to be used as 
security, together with other than United States bonds. 
Then it was that Mr. Vreeland drew up his bill, with an 
evident understanding with the Senate leaders on this 
point. In fact, the wording of the Vreeland Bill on this 
matter was the same as the wording of the act which was 
the final outcome of the conference between the two 
Houses. 

We have here, however, what undoubtedly proved a 
surprise to the banking public, who naturally supposed 
that the law incorporated the purport of the compromise. 
As a matter of fact, the supposed intention of Senator 
Aldrich was not expressed in the law as passed, whether 
from conscious intent, or ignorance of English, or of the 
character of banking paper, it is hard to say. But it is 
unlikely that so astute a politician did not fully know 



THE ALDRICH-VREELAND ACT 69 

what he was doing. Moreover, the manner of making 
the error was possibly due to his zeal in trying to include 
railway bonds in the general class of those other than 
United States bonds. It will be remembered that the 
Aldrich Bill included in this class 

the first-mortgage bonds of any railroad company, which, in 
compliance with existing law, reports regularly to the Inter- 
state Commerce Association a statement of its condition and 
earnings, and which has paid dividends of not less than 4 per 
centum per annum regularly and continuously on its entire 
capital stock for a period of not less than five years previous 
to the deposit of the bonds (Section 2). 

Owing to the political clamor against the railways, Sen- 
ator Aldrich had to see this provision expunged from his 
bill. But when the bills of the two Houses were in con- 
ference, it was possibly not noticed that the original 
phraseology of the Vreeland Bill, and that finally enacted, 
allowed "any securities, including commercial paper, held 
by a banking association" to be used as security under 
the direction of the secretary of the treasury. "Any 
securities" included not only first mortgage railway 
bonds, but any of the $16,000,000,000 of railway securi- 
ties which might be held by any banking association, and 
accepted by the secretary. Nor were any reports to the 
Interstate Commerce Commission made necessary, nor 
the payment of dividends, as mentioned in the Aldrich 
Bill. And soon the secretary was confronted with the 
awful responsibility of deciding which of all these multi- 
farious railway securities he ought to accept. It was a 
condition of things highly satisfactory to politicians and 
to bond dealers. If a security was accepted by the secre- 
tary every national bank would be informed that it 
was a good security for bank-notes. Such action would 



70 BANKING PROGRESS 

give a bond or stock a valuable indorsement and greatly 
enhance its value. It opened up unlimited possibilities 
for pressure. It was an intolerable and an unforeseen 
situation. 

But the inclusion of railway securities by the words 
"any securities" really introduced the greatest surprise 
of all into the new law. Without a shadow of doubt the 
language used was so broad and sweeping that it allowed 
the banks to offer any assets held by them, other than 
"commercial paper," as specifically defined in the act, 
and to which it was generally supposed the banks were 
limited. The very pains taken to define "commercial 
paper" would lead one to suppose that only that descrip- 
tion of paper would be accepted. Such, however, was 
not the law. The act, as already quoted, runs as follows : 

The national currency association herein provided for shall 
have and exercise any and all powers necessary to carry out 
the purposes of this section, namely, to render available, under 
the direction and control of the Secretary of the Treasury, as 
a basis for additional circulation any securities, including com- 
mercial paper, held by a national banking association. 

The powers here granted were sweeping; and the pur- 
pose of granting these large powers was denned to be: 
to render available as a basis for additional circulation 
any securities (including one specified kind) held by a 
national bank. The words "any securities" were used 
as a general or generic term, covering not only bonds, 
but such securities as commercial paper. Obviously, as 
the language runs, the words included anything other 
than "co mme rcial paper" which could properly be in- 
cluded under the term "any securities." The interpre- 
tation hinges upon the meaning of the word "securi- 
ties." In the accounts of the Bank of England the term 



THE ALDRICH-VREELAND ACT 71 

employed to cover all loans to customers is "other securi- 
ties." In fact, in American banking usage, the word 
securities is commonly applied to any of the notes, col- 
lateral, or other paper, held to secure the repayment of a 
loan. It is a generic term. 

The word "securities" was possibly not used with pre- 
cision in the act. Clearly, it was not intended to be made 
synonymous only with bonds. Probably it was pur- 
posely left ambiguous. After making the general state- 
ment about "any securities, including commercial paper," 
the act speaks of the deposit, in trust for the United States, 
of "such of the securities above mentioned as may be 
satisfactory to the board of the association." Here 
securities include, of course, commercial paper. Again, 
in sec. 1, the word appears generically as follows: 

If he [the Secretary] be satisfied with the character and value 
of the securities proposed, and that a lien in favor of the United 
States on the securities so deposited and on the assets of the 
banks composing the association will be amply sufficient for 
the protection of the United States, etc. 

Here, the context shows that the word "securities" in- 
cludes the discounted bank paper on which notes could 
be issued only to 75 per centum of "the cash value of the 
securities so deposited"; for this amount of 75 per cen- 
tum is put in opposition to the 90 per centum of notes 
to be issued, if the basis furnished is made up only of 
bonds. 
Again in sec. 9, in regard to the tax, it is said: 

National banking associations having circulating notes se- 
cured otherwise than by bonds of the United States shall pay 
for the first month a tax at the rate of 5 per centum per annum 
upon the average amount of such of their notes in circulation 
as are based upon the deposit of such securities, and afterwards 



n BANKING PROGRESS v 

an additional tax of 1 per centum per annum for each month 
until a tax of 10 per centum per annum is reached, and there- 
after such tax of 10 per centum per annum, upon the average 
amount of such notes. Every national banking association 
having outstanding circulating notes secured by a deposit of 
other securities than United States bonds shall make monthly 
returns, under oath of its president or cashier, to the Treasurer 
of the United States, in such form as the Treasurer may pre- 
scribe, of the average monthly amount of its notes so secured 
in circulation; and it shall be the duty of the Comptroller of the 
Currency to cause such reports of notes in circulation to be 
verified by examination of the banks' records. The taxes re- 
ceived on circulating notes secured otherwise than by bonds 
of the United States shall be paid into the Division of Redemp- 
tion of the Treasury and credited and added to the reserve 
fund held for the redemption of United States and other notes. 

Obviously, the tax is the same on notes based on bonds 
other than United States bonds, and on commercial 
paper. If so, the word "securities" was used generi- 
cally to include both kinds of protection to the notes. 

The act, then, permitted the issue of notes on (1) 
United States bonds, (2) on approved bonds other than 
United States bonds, and (3) on "any securities, including 
commercial paper, held by a national banking associa- 
tion." It distinctly did not confine the issue of notes 
under (3) only to commercial paper — although it defined 
commercial paper specifically; and although it provided, 
in sec. 1: 

That no national banking association shall be authorized in 
any event to issue circulating notes based on commercial paper 
in excess of 30 per centum of its unimpaired capital and surplus. 

What then was the meaning of "any securities," other 
than "commercial paper"? Possibly Congress meant 
to separate the class of bonds distinctly from the class of 
"commercial paper," and to use securities only as a 



THE ALDRICH-VREELAND ACT 73 

synonym for bonds. Under this supposition, notes could 
be based only on (1) United States bonds, (2) other ap- 
proved bonds, and (3) commercial paper, as defined. If, 
however, this was the intention, it was certainly not so 
expressed in the law. For, as we have seen, "securities" 
were not synonymous with bonds; and any securities 
other than bonds were permitted, including "commercial 
paper." 

Why, then, was commercial paper defined, and the 
issues based upon them limited to 30 per cent of the cap- 
ital and surplus? The definition is as follows: 

The term "commercial paper" shall be held to include only 
notes representing actual commercial transactions, which when 
accepted by the association shall bear the names of at least 
two responsible parties and have not exceeding four months 
to run. 

Possibly, it was the intent of Congress that the only 
bank assets on which notes could be based was com- 
mercial paper; but, irrespective of this definition and of 
the 30 per cent clause, a currency association was given 
"any and all powers necessary ... to render available 
... as a basis for additional circulation any securities, 
including commercial paper, held by a national banking 
association." As the law stood, if the association was 
limited to 30 per cent of its capital and surplus, when 
presenting "commercial paper," it was not so limited if 
it presented other bank paper not classifiable as "commer- 
cial" under the definition. In truth, those assets of a 
bank which did not come under the definition of "com- 
mercial paper" were given more liberal treatment than 
"commercial paper," and were placed outside of the 
operation of the 30 per cent clause. 
Undoubtedly, some members of Congress must have 



74 BANKING PROGRESS 

thought they had shut off the issue of notes on all assets 
(exclusive of government, or other bonds), except com- 
mercial paper. They probably wanted to distinguish 
between "accommodation paper," or "finance bills," on 
the one side, and legitimate commercial paper, on the 
other. But the sweeping general clauses of the act did 
not confine the securities other than bonds to com- 
mercial paper, as defined in the act. The wording of the 
law left the gates wide open for the deposit of any securi- 
ties (i. e. 9 any kind of paper) held by a national bank, 
and offered by a currency association, subject only to 
"the direction and control of the Secretary of the Trea- 
sury." At least, that is the only possible interpretation 
which, in my opinion, would be given by the courts. And 
these are the reasons for the previous statement that the 
law provided the means for a large expansion of notes in 
a time of emergency — a freedom quite unexpected even 
by advocates of "asset-currency." Moreover, the House 
was put in control of the situation; for, if an attempt 
had been made by the Senate to amend its mistakes, the 
House, in which there was a majority against bond-secured 
circulation, could have retained the law as it stood. 
Any repeal or amendment required the consent of the 
House. This was certainly a startling outcome of the 
currency struggle. 

The new law introduced some difficulties before addi- 
tional notes could be issued; but after that point was 
reached, the gates were certainly left wide open. In 
case of another panic such as that of 1907, the scramble 
for currency would be avoided, the reserves more or less 
protected, the resort to clearing-house checks for cur- 
rency in daily use prevented, and a sense of insecurity 
due to inability to get currency would be removed, were 
this Aldrich-Vreeland Act — as interpreted above — then 



THE ALDRICH-VREELAND ACT 75 

in force. 1 Of course, it could not prevent a future panic. 
No act could do that. 

In addition, the notes were perfectly safe. The banks 
must keep in the redemption fund (sec. 6) a sum equal to 
5 per cent of its additional circulation (other than that 
based on United States bonds), as distinct from the 
original 5 per cent redemption fund of June 20, 1874. 
Thus for immediate redemption it would seem that for 
notes secured by United States bonds, only 5 per cent 
was required, but for all notes otherwise secured, 10 per 
cent. The Treasury was obliged to redeem the notes; 
but, besides the securities deposited, the Treasury could 
have recourse to all the assets of all the banks in a cur- 
rency association. The taxes paid, moreover, were to 
be turned into the division of redemption and added 
to the reserve fund held for the redemption of United 
States and other notes, thus constituting a potential 
safety fund in the future. 

Also, banks had to pay a uniform rate of interest 
throughout the country of at least 1 per cent on govern- 
ment deposits; but no reserves were to be held against 
such deposits. Nor were any reserves against notes 
required. 

§ 6. The Aldrich-Vreeland Act in its attempt to de- 
fine "commercial paper," thus opened up the whole 
question as to the nature and classification of banking 
assets. The contemptuous rejection by the leaders of 
all advice from bankers undoubtedly got the framers of 
the law into unsuspected difficulties. 

If only "commercial paper" as defined in the act were 
accepted, then there would have been excluded all loans 
based on legitimate transactions bearing only one name. 

1 Cf. the experience in the panic of 1914. Chapter XI, § 7. 



76 BANKING PROGRESS 

Thus the one-name notes of a great merchant, or the 
U. S. Steel Corporation, would be excluded. The sale 
of goods would thus be no basis for a discount, unless 
such a firm went out and obtained an additional name. 
Such a discrimination was not only unfair, but it ignored 
the actual trade methods used in this country. 

Practically, the only way in which two-name paper, 
based on actual transactions, is presented for discount 
in this country, is that in which so-called "trade-paper" 
is created. When a merchant buys goods in the United 
States on time, he receives a greater or less discount for 
paying cash before the account is due. This discount 
varies in different trades. In groceries, food products, 
etc., the sales are usually on 10 days time, and the dis- 
counts play no real part. In the sale of luxuries, such as 
fine millinery, or jewelry, the period allowed for payment 
of goods may be 6 months. But in trades like hard- 
ware, the time runs from 30 to 90 days. Hence, if a 
discount of 3 per cent is allowed by the seller, provided 
cash is paid in 10 days on goods sold at 90 days credit, 
that is equivalent to 3 per cent for 80 days, or at a rate 
of 13j^2 per cent per annum. Likewise, a discount of 2 
per cent for cash paid in 30 days is equal to 12 per cent 
per annum. Now, if the buyer has good standing he 
can borrow at 4 or 5 per cent, and pay off his account, 
thereby saving the difference between 4 or 5 and 12 or 
13J^ per cent. The longer the time on which goods are 
sold, the larger the discounts and the greater the induce- 
ment to borrow and to anticipate payment of the account. 
Consequently, the merchants having the best credit 
never wait until their accounts mature; some of poorer 
credit meet payment at maturity; and others, not able 
to pay when the accounts fall due, must borrow and meet 
one indebtedness by creating a new one. Now, this last 



THE ALDRICH-VREELAND ACT 77 

class, the poorest of all, creates two-name paper, based 
on actual transactions, on less than 4 months time 
usually, which would be technically acceptable as "com- 
mercial paper" security for note-issues; while the paper 
of the men of higher credit, who can always borrow and 
save on the trade discounts, would not be acceptable. 
The framers of the act were lamentably ignorant of Ameri- 
can trade methods and the nature of banking paper. In 
fact, the definition of "commercial paper" pivoted mainly 
on the requirements of two names. But it is obvious 
that this requirement would rule out some of the best 
paper held by banks. 

In order to get a clear idea of the kind of assets held 
by national banks, having chiefly a mercantile clientele, 
the following classification given to the comptroller by 
a certain well-managed bank will give us the average 
condition of such institutions: 



A. On demand, paper with one or more individual or firm 

names $2,231,184.06 

B. On demand, secured by stocks, bonds, and other per- 

sonal securities 4,063,083.61 

C. On time, paper with two or more individual or firm names 8,350,629.34 

D. On time, single-name paper, one person or firm without 

other security 9,497,384.44 

E. On time, secured by stocks, bonds, and other personal 

securities. 5,604,183.75 

F. Secured by real estate, mortgages, or other lien on real 

estate 28,820.00 

$29,775,285.20 



Apparently, according to the definition in the Aldrich- 
Vreeland Act of the paper allowable as security for notes, 
through currency associations, only class C could be ac- 
cepted, and only that part which could be strictly con- 
strued as based on actual transactions. Yet, according 



78 BANKING PROGRESS 

to bankers, this is not as a rule the best banking paper 
held. 

As every one knows, also, the banks dealing mainly in 
loans of a mercantile character are large buyers of paper 
sold by note-brokers. Such notes are rarely secured by 
collateral, and usually bear one name. In the case of 
large corporations the indorsement of more than one 
officer of the company could not make two-name paper. 
In spite of some faults in such loans — doubtless remediable 
— the extent of the dependence on note-brokers is wide- 
spread. The situation is well expressed by a prominent 
banker 1 as follows: 

The ease with which loans are obtainable in normal times by 
responsible houses on their own direct, unsecured obligations, 
through the agency of note-brokers, has nearly done away 
with trade-paper [i. e., two-name commercial paper] of the 
highest grade. All good concerns and many even in second 
and third grade credit are enabled to borrow all the funds 
required to take advantage of trade discounts, and enough 
more to meet all other bills at maturity, so there is little or no 
reason to settle trade accounts by notes. . . . No house can 
habitually do so without ultimate damage to its credit. The 
business of the note-broker in directly supplying capital when 
needed by solvent borrowers for production use in trade is 
comparatively a modern occupation, and it is highly beneficial 
if confined within legitimate and prudent limits. In this 
country the business has developed enormously within two or 
three decades and along lines that were unthought of a few 
years ago and which then would have been deemed impossible 
and extremely hazardous. The system as we know it is not 
in common practice anywhere else in the world. 

All such paper obviously would be excluded by the legal 
definition of "commercial paper" in this act. 

1 Joseph T. Talbert, president of the Chicago Clearing-House, " Commercial 
Credits," an address before the New York State Bankers' Association, July 10, 
1908. 



THE ALDRICH-VREELAND ACT 79 

The loans of modern banks are, of course, of all kinds; 
but a rough division may be made as follows: (1) loans 
to customers of a mercantile character; (2) notes pur- 
chased of note-brokers, and (3) loans to stock-brokers 
and individuals. The last class (3) are usually demand 
loans, and are generally fully secured and usually quite 
safe, being margined on quickly salable securities. There- 
fore, if only "commercial paper," as defined, were ac- 
cepted as security for notes, classes (2) and (3) and a large 
part of (1) would be refused. Yet, in the report of the 
New York Clearing-House Association for the period 
from October 26, 1907, to March 28, 1908, during which 
the gross issue of certificates during the panic conditions 
was $101,060,000, collateral of the various classes of 
assets mentioned above was used as security for the 
issue of certificates, to the amount of $330,000,000 or 
72.92 per cent of all securities; and yet not a dollar was 
lost in that whole time of crisis and danger. 

In conclusion, if the loose wording of the act were in- 
terpreted as has been claimed above — and no other seems 
possible — the banking paper which did not come under 
the legal definition of "commercial paper" had to be 
accepted as security for notes; it had to be accorded the 
same treatment as any securities (other than United 
States bonds) held by a banking association; the amount 
of notes issuable on such banking paper (other than 
"commercial paper") was not limited to 30 per cent of 
the capital and surplus; and notes could be issued to the 
amount of 75 per cent of the market value of those securi- 
ties. The valuation of the securities, whether bonds or 
banking paper, and the decision as to which should be 
accepted, finally rested with the secretary of the treasury. 
What a paradise for the climbing politician ! Soon he 
became active in obtaining government deposits for banks 



80 BANKING PROGRESS 

in his district; and he had new worlds for conquest in 
pressing local securities upon the magic list of the Trea- 
sury which was to give them a new value and advertise- 
ment at no cost. Certainly, we had in this Aldrich- 
Vreeland Act — the product of a few days struggle at 
the end of a session — an unexpected freedom of issues 
based on banking assets, as well as a Pandora's box full 
of unknown possibilities for evil. It was an amazing 
lesson on the folly of politics in banking. 



CHAPTER V 
GUAKANTY OF BANK-DEPOSITS 

§ 1. In the wake of a financial crisis are always to 
be found numerous proposals to give the monetary world 
permanent security. Already we have seen how the 
persistence of the idea that panics could be eliminated by 
issues of paper money produced legislation in 1908 of a 
hasty character. In the period following the panic of 
1907 public attention was diverted from matters touch- 
ing the issue-function to matters concerning the deposit- 
function of banks. Out of this discussion much was added 
to our thinking on banking. The essential purpose of a 
bank is to lend. If the loan is legitimate and the security 
good, the bank buys the right to receive a definite sum in 
the future and gives to the borrower a right to draw on de- 
mand. This immediate liability which the bank creates 
as the result of a loan may take either of two forms, 
according to the business habits of the community and 
the preference of the borrower: (1) the issue to the cus- 
tomer of the bank's own notes (or other cash) ; or (2) the 
grant to him of a deposit-account for the amount of the 
loan (less the bank discount). Hitherto the issue of 
bank-notes had received the chief attention. It is inter- 
esting, therefore, in following the slow steps of banking 
progress to note that the next development came in con- 
nection with the deposit-function. Such a shift of inter- 
est, even though it may have produced many fallacious 
schemes, pointed toward our final objective, the better 
organization of credit. For credit works mainly through 
the deposit-function. This new agitation we owe, as 

81 



82 BANKING PKOGRESS 

also in the case of silver, largely to the activity of am- 
bitious politicians. Although we have many serious- 
minded statesmen, still a measure is not infrequently 
judged by its power to gain votes for the party in power 
in the next election. Consequently, the candidate for 
office is eagerly searching the field for schemes which 
can be regarded as personal belongings, and which will 
appeal to uninformed masses quite independent of their 
true ethical or monetary quality. 

Of such a character was the "rag baby" of greenback 
days, or the free coinage of silver of more recent memory; 
and the last member to be added to this motley collec- 
tion is the guaranty of bank-deposits. Its appearance 
soon after the financial crisis of 1907 found honest sup- 
porters, not only from those who were injured by the in- 
ability to withdraw deposits in the days of the panic, 
but also from those who believed they had found in it 
a means of preventing panics. Superficial thinking as 
to panics, and little understanding of the actual opera- 
tions of banks, have provided a soil in which the proposal 
for a guaranty of bank-deposits may take* quick root. 
In the interests of a sound basis for our monetary and 
banking institutions, it is well worth the while to give a 
searching examination to a scheme which has been pro- 
posed not only for the State but also for the national 
banks, and which has already become law in several of 
our States. It cannot be regarded as a dead issue so 
long as it is recommended to Congress by the comptroller 
of the currency. 1 

§ 2. The purpose of the scheme is to distribute the 
losses to depositors arising from bank failures among a 
large number of banks, instead of allowing them to fall 

1 See Federal Reserve Bulletin, May, 1918, p. 429. 



GUARANTY OF BANK-DEPOSITS 83 

on the innocent depositors who were not responsible for 
them. To this end it is proposed to levy a tax on the 
bankers to create a fund which, in charge of the State, 
shall be used to pay off at once the claims of depositors 
in insolvent banks. Some advocate the guaranty of the 
government or State, others lay the whole burden on the 
banks, aided, perhaps, by an initial grant from the gov- 
ernment. There is, however, no agreement as to the 
actual working of the plan: (1) some insist that its essen- 
tial value lies in saving the depositor from waiting for 
his funds until the liquidation of the bank's assets; 
while (2) others think it is only to assure the depositor 
against ultimate loss, in case the assets are insufficient 
in the last resort. There is a difference between these 
two objects: the former provides for immediate, the 
latter for ultimate, redemption of deposits. Arguments 
for the one would not apply to the other. At first, the 
benefit was supposed to centre about the ability of the 
depositor in the failed bank to cash his claim at the 
very time when emergency conditions were dangerously 
pressing upon him. Hence, he should not be crippled by 
loss of his means in a time when he must meet maturing 
obligations. This view, however, seems to have been 
abandoned as untenable, because it was quickly pointed 
out that in the panic of 1907 deposits of more than $100,- 
000,000 were tied up; and to pay off this sum on demand 
would have required an accumulated guaranty fund 
much larger than that mentioned by any of its advocates. 
The Fowler Bill evidently assumed that $25,000,000 
would be enough, while elsewhere $50,000,000 was 
thought sufficient. On the other hand, if the fund were 
intended only for the ultimate redemption of depositors' 
claims, it would not prove of much advantage to the 
man in the hour of panic. The panic and the vital need 



84 BANKING PROGRESS 

would be long gone by before the claim was realized 
upon. 

In proposing to guaranty depositors in general there 
is an obvious lack of discrimination in failing to distin- 
guish between depositors in savings-banks, whose assets 
must necessarily be given a long-time investment char- 
acter, and depositors engaged in active business, who 
have checking accounts at commercial banks which must 
always keep assets in cash sufficient to meet normal de- 
mand requirements. For this first class savings-banks 
under the laws of the various States are created; but, ob- 
viously, not all States have been careful in providing 
safety for such depositors. These small depositors are 
the ones usually referred to when pictures are drawn of 
the misery entailed upon persons who could have had no 
means of deciding whether one bank was safer than an- 
other. The protection for depositors in savings-banks 
(or small private banks) is a wholly different problem 
from that for depositors in commercial banks. 

It is for this first class that government postal banks 
were suggested as offering absolute safety. Apart from 
the inevitable difficulties arising from the investment of 
hundreds of millions of dollars by government officials, 
and the selection of securities — very grave difficulties — 
there could be no doubt as to the safety provided by the 
State for all depositors who would be thought incapable 
of intelligent choice of a bank in which to make time-de- 
posits. Therefore, government postal banks should re- 
move much of the sentiment manufactured for consump- 
tion among the small depositors of the country in favor of 
the insurance of bank-deposits. Moreover, by caring for 
this class of persons, who might be victimized by unprin- 
cipled bankers, the case for the guaranty of deposits in 
commercial banks which are left there by active and 



GUARANTY OF BANK-DEPOSITS 85 

keen business men — who, moreover, usually deposit where 
they can also get loans — can be better treated by itself. 
Nor has the establishment of a government savings sys- 
tem, in my judgment, had any appreciable effect on the 
sums left with the commercial banks. 

The real question, therefore, has to do with com- 
mercial banks, such as our national banks, and some of 
those created by the States; for the trust companies and 
State banks, while carrying on savings departments, also 
strive actively for the business of commercial banks, and 
cannot by any means be ignored. Later, however, the 
national banks were prevented by a decision of national 
officials from joining any guaranty schemes. Yet, in the 
main, the national banks received the greatest attention 
in the discussion. The point was raised that because the 
national banks issue notes, the insurance of these notes 
by a guaranty fund, providing for their immediate re- 
demption, has been generally admitted as desirable and 
feasible; even though their ultimate redemption must be 
secured by a first lien on assets or by the deposit of bonds. 
If, then, the insurance of the noteholder is regarded as 
necessary, why not extend the same idea to the depositor ? 

§ 3. There is, however, a wide difference between the 
position of the noteholder and that of the depositor. 
When a demand-liability of a bank, in the form of a note, 
comes to be used as money, and is passed from hand to 
hand by buyers and sellers who have no knowledge what- 
ever of the standing of the issuing bank, it must have 
universal acceptability. It should be no more neces- 
sary for each receiver of the note to stop and ascertain 
the solvency of the issuer than it should be necessary 
for the receiver of a gold coin to stop to test and weigh 
the fineness of the metal contained in it. It is not in 



86 BANKING PROGRESS 

the interest of the bank, but in the interest of the busy 
public, that protection is thrown around the issue of 
notes. In its work as a medium of exchange the note 
often goes forth to a great distance from its place of issue, 
and often remains in circulation for a long period before 
being returned for redemption. It is quite otherwise 
with the deposit-currency. While the note performs a 
general and social function, a deposit arises solely from a 
personal and voluntary act. Deposit-currency can never 
possess such a universal and general character, because 
each particular check must always submit to proof of the 
existence of funds sufficient to meet the order. The 
noteholder is usually an involuntary, and the depositor 
a voluntary, creditor of the bank. The use of a deposit 
always implies recourse to a bank in order to give it effect 
in payment; while a note requires no proof, no indorse- 
ment, no identification in establishing its right to move 
in the world of exchange. The depositor selects his own 
bank and takes the risks implied in a voluntary choice, 
thus becoming responsible for his act, just as any one does 
who gives credit to a buyer or lets a house. Consequently, 
the reasons for a guaranty of the notes are obvious; 
while they would have no application to the guaranty 
of deposits. If it be said that depositors are often ig- 
norant of the soundness of one bank as compared with 
another, it may be answered that such an excuse might 
be admitted for the class of small savings-bank depositors, 
but not for the ordinary man of business who deals with 
a commercial bank. There are abundant means for find- 
ing out the standing of banks in any city. Or, if it be 
said that no depositor, not a director, knows what is 
going on on the inside of a bank, so it might be said 
that a seller of goods on credit does not know what the 
distant buyer is doing with his purchased goods, for which 
he has not yet paid. 



GUARANTY OF BANK-DEPOSITS 87 

§ 4. A depositor is, of course, a creditor of a bank; 
that is, the relation of a depositor to a bank is only one 
of many other relations existing between creditor and 
debtor. Is there anything peculiar in the case of the 
depositor which sets him apart from all other creditors, 
who have voluntarily entered into a creditor relation, 
and which entitles him alone to protection against the 
consequences of his own acts? If one sort of creditor 
should be insured against the usual mischances of busi- 
ness, why should we not insure all? Why discriminate 
in favor of him who is rich enough to have a bank-deposit ? 
A humble washerwoman who often has outstanding debts 
which she cannot collect ought to be insured against loss 
as well as a depositor; she has little means of knowing, 
except by bitter experience, whom to trust. And the 
same might be said of the cobbler, the milkman, the 
grocer, the doctor, the merchant, or the large wholesale 
seller of dry-goods, or the seller of any other article; for 
they have accounts against others for which they need 
the collections as well as the depositor in a bank — per- 
haps more. Why this sudden access of interest in the 
creditors, when in the silver agitation every true patriot's 
heart was burning with zeal to help out the poor debtor ? 
Has the politician exhausted the possibilities of sympathy 
in the debtor, and wishes to try new pastures? Cer- 
tainly, the proposal to insure depositors as an application 
of a general principle of insuring all creditors does not 
seem to be practical. 

Pathetic pictures have been drawn of the misery cre- 
ated by the failure of a private State bank in Chicago, 
the Milwaukee Avenue Bank: how innocent men and 
women lost a life's savings; how foreigners saw their 
fortunes disappear before they had become settled in the 
new land; how small dealers were ruined; how some 



88 BANKING PROGRESS 

became insane and others committed suicide. Then, it 
was added, almost the whole of the deposits were in the 
end paid out of the assets by the receiver. Hence, if 
the deposits had been guaranteed and the depositors had 
been paid off immediately, all this misery would have 
been saved. No one would depreciate the frightful re- 
sults of this unpardonable wrong-doing; but is this the 
only kind of misery to be cared for? And should the 
State consciously engage to care for all such cases arising 
from accident or fraud? Let us turn from the picture 
just given to another. An honest and successful dealer 
was selling goods to Southern buyers before the Civil 
War. On the breaking out of the conflict he found all 
his outstanding debts uncollectible; he was ruined; his 
children had even to be withdrawn from school and set 
to work for their bread; and this man, broken down, ended 
his life in the poorhouse. He lost everything; while, 
in the other case, depositors who waited recovered most 
of their deposits. If depositors suffer from no error of 
their own, so also did our merchant suffer from no error 
which he could have repaired. In both cases, the per- 
sons had acted voluntarily, and both had to take the 
chances going with acts of their own choice. When all 
evil and possibility of misjudgment have gone from our 
world, then, and only then, may we think of insuring the 
whole class of creditors, including the depositor. 

There is no justice in laying the depositor's losses, for 
which he is not responsible, upon others who, also, are not 
responsible for the losses. The honest and efficient 
banks cannot in justice be asked to make up to a depositor 
in a failed bank losses for which the honest and efficient 
banks had no responsibility whatever. It would be 
clearly unfair to hold a small, conservatively managed 
country bank responsible for the "frenzied finance" of 



GUARANTY OF BANK-DEPOSITS 89 

some large bank in a great city. All reason, all justice, 
demand that the punishment be inflicted on the doer of 
the wrong and not on the innocent neighbor. In fact, 
the ethical justification for taxing sound banks to cover 
the lapses of unsound banks has no existence whatever. 
It is unmoral. Moreover, it is a question whether the 
courts should enforce such a law against the rights of 
property. 

§ 5. More than that, it is not supported by any 
theory of political expediency but the socialistic. The 
advocates of insurance deplore the suggestion that it is 
socialistic, and are as much horrified by the mention of 
socialism as the devil is by the sight of the cross; and 
yet what does the analysis show? It is not necessary 
to explain to intelligent readers that socialism is not cor- 
rectly defined by saying that it is opposed to individual- 
ism; socialists look to the State to do for them what 
they admit that they cannot do for themselves under a 
system of free competition. They charge against the 
forms of society what is due to the deficiencies of human 
nature, assuming that a change in the forms of society 
will change elemental human nature. The failure to 
hold their own in the struggle of life is the incentive to 
socialistic thinking. Disagreeable as it may sound, in 
reality socialism is the philosophy of failure. To be asked 
to be relieved from the ill success, or risk, of one's own 
business ventures is of the very essence of socialism. 1 
When human nature has changed its spots, and can be 
trusted to go straight without existing incentives, then 
without expecting a depreciation of human fibre we may 
begin to remove the dread of loss from those who make 
mistakes. It is only because men must look out for 

1 See Laugbiin, Latter-Day Problems, revised edition, chap. II. 



90 BANKING PROGRESS 

themselves that they differ in business fibre from women 
and children who are separated from the world of com- 
petitive effort. One may admit all the distress arising 
from the inability of the depositor to draw his deposits 
in cash; and yet one would not, as a consequence, need 
to demand insurance against every emergency in which 
misery may arise from the hazards of business. The 
essential idea in the scheme for guaranteeing deposits in 
commercial banks— quite apart from the humble savings- 
bank depositor — is to relieve a man from the responsi- 
bility for using bad business judgment; and it is based 
on the principle of freeing men from the results of all 
business engagements in which there may be a risk of 
loss. If we once begin on this principle, we must care 
for all those who have entered into the relation of creditor 
to another. The scheme is the product of a narrow 
mind which has seen only one superficial phase of the 
problem, and which has hurried to a general conclusion 
without having studied the wide-reaching effects of an 
enervating and impractical policy. 

Indeed, the origin of the guaranty idea is traceable 
either to the general prejudice against banks or to the 
attempt to make men good by law. It is purely popu- 
listic, or socialistic, in its parentage. On the one hand, 
it seems to be based on the belief that banks are rich and 
ought to bear the burdens of the unsuccessful. If some 
banks are badly managed, then make the whole rich 
banking fraternity bear the losses. Thus, by hook or by 
crook, no matter whether the system is just or unjust, 
the bankers will have to get out of it among themselves 
the best way they can. They can stand it better than 
anybody else. Let the moral question go hang. In the 
second place, the plan is an attempt falsely to make one 
banker as good as another by law, when we all know that 



GUARANTY OF BANK-DEPOSITS 91 

by nature they must differ with differences in skill and 
integrity. The supporters of the guaranty system are 
evidently appealed to by the socialistic quality in it. 
The unsuccessful banker may have a grudge against the 
successful one; and then it is easy to get favor for a law 
which would help them to escape the results of their own 
failures and to draw down to their own level those who 
have succeeded. In reality, there is only one royal road 
to large deposits: that lies through skill, integrity, good 
management, and time enough to enable the public to 
learn of the existence of these qualities. 

§ 6. In some of the pleas for insurance, deposits are 
supposed to be "all the money people possess," "the 
people's cash," a "huge volume of money." Since this 
sum, fabulously large, is in the banks, the whole business 
fabric, it is assumed, must rest upon the banks. The 
only thing which sustains this critical situation is supposed 
to be the confidence of the depositors in the bank; when 
time of stress comes this confidence gives way to dis- 
trust, followed by a scramble for cash. Then, says the 
insurance advocate, do that which will establish per- 
petual confidence by the depositor in the bank, and we 
shall never more have panics. The plan is so compact, 
so easy, that it recalls at once the naive method by which 
the Chinaman got his supply of roast pig. 

Probably it has never occurred to such theorists to 
examine the payments to a bank by depositors in any 
one day. If they had, they would have found that in 
large cities the cash paid in was insignificant in amount 
compared with that paid in in checks drawn on deposit- 
accounts. Moreover, the deposit item in the national 
banks now moves in close correspondence, in amount and 
in changes, with the loan item. In fact, a loan is im- 



92 BANKING PROGRESS 

mediately followed by the granting of a deposit in favor 
of the borrower. That is, the mass of deposits in com- 
mercial banks are largely the result of loans; and the 
creation of a demand-deposit following a loan is always 
accompanied by leaving an equivalent value, as the se- 
curity for the deposit, in the assets. The loan given for 
carrying wheat or cotton 30 or 90 days creates a demand- 
deposit which can be drawn upon on demand by the 
borrower; but the assets constitute in effect a claim over 
the wheat or cotton, or its equivalent value, which will 
issue in some means of payment in 30 or 90 days. If 
the goods are salable, the deposits are safe. In short, 
the deposits are as safe as the assets on which they are 
based. Provided loans are based on commercial paper, 
the deposits are as safe as the quick goods passing be- 
tween buyer and seller. The deposits, therefore, depend 
for their safety upon the kind of assets taken by a bank 
for a loan; they do not depend upon an abstraction like 
"confidence." To secure safety to the depositor, all 
attention should converge on the quality and liquid na- 
ture of the assets in the loan account. In order to have 
confidence, we must primarily see to it that loans are 
made with good judgment. The whole matter pivots on 
this consideration. The only way to avoid a crisis is to 
avoid expansion; which is only another way of saying, 
avoid taking assets which will not certainly protect the 
deposits when liquidation is enforced. 

§ 7. When, therefore, insurance of deposits is pro- 
posed as a means of preventing panics, because it will 
secure confidence, we are confronted with a singularly 
crude understanding of the causes of panics and of what 
the operations of a bank really are. Confidence, of course, 
has its place in these matters; but we can have confidence 



GUARANTY OF BANK-DEPOSITS 93 

only if there is a basis for confidence. If freight is sent 
on a railway, accidents cannot be avoided by serenely 
leaning back and assuming — after Christian Science 
methods — confidence. If the railway is carelessly man- 
aged and poorly equipped, there will be wrecks and de- 
struction of freight, no matter what the mental attitude 
of the shipper is. But then, says the insurance advocate, 
tax all the railways for an insurance fund to pay for the 
losses; and, then, notice how all the good railways will 
report upon the bad ones, with the result that there will 
be no more accidents. This illustration brings forth 
the gist of the whole question. You can prevent acci- 
dents and losses only by directing your discipline to men 
and equipment; you can secure safety by correct railway 
methods, not merely by requesting confidence. No, say 
the insurance advocates, establish a guaranty against 
all losses, and you will have confidence, no matter how 
badly a railway conducts its service; and, if good rail- 
ways must contribute, they will see that the bad rail- 
ways have no more wrecks. Imagine, in practice, the 
outcome if the Pennsylvania Railway were to be called 
upon to pay for damages due to accidents on the Erie 
or on the Baltimore and Ohio. The Pennsylvania, if 
well and safely conducted, has enough to do to watch 
its own road, to say nothing of a road over which it has 
no daily and direct control. If the poor road were free 
from all responsibility for damages due to its own manage- 
ment, what incentive would there be to improve its 
methods? Insuring the goods may reimburse the ship- 
per, but it does not touch the internal conduct of the road. 
And, if a good road gets no advantage from its fine road- 
bed, its solid bridges, its well-trained force, why should 
it keep up its superior condition? If it does not gain 
traffic by its superior condition over an inferior road, 



94 BANKING PROGRESS 

there is no reason for expenditure of mind and money in 
safeguards. 

The parallel between the railways and the banks is 
practically complete. Confidence in banks can be due, 
not to external forces, like insurance of any losses which 
may occur, but to internal forces directed upon the 
methods of business management, and the quality of the 
assets which serve as the security for the deposits. If 
the internal management is careful and judicious,, the 
deposits are safe, and we can have confidence in their 
safety. Moreover, if a good bank gets no advantage 
from its sound business methods, its conservative loans, 
its skill in avoiding losses, and its experienced staff, why 
should it try to keep a superior standard? The insur- 
ance idea seems to be that we can have confidence in 
banks, if only some one will pay the losses. This is as 
much as to say, we are not afraid of fire, even if incendi- 
aries are about, because we are insured; when, in truth, 
the only permanent confidence is due to measures which 
will eliminate the incendiaries. So, in banking, every- 
thing is secondary to the character of the banking man- 
agement and of the assets in the loan item. 

It cannot be insisted upon too strongly that the effort 
to create confidence and prevent panics by insurance of 
deposits is taking hold of the wrong end of the problem. 
The deposits, as has been said, can never be any safer 
than the assets. Therefore, if we wish to create con- 
fidence and prevent panics, every effort should be directed 
to securing only the safest kind of assets. This is the 
crux of the whole matter. To talk only of insurance, 
and to minimize the importance of the quality of the 
assets, is only to act after the damage is done; to close 
the stable-door after the horse is gone. To take away 
responsibility for banking losses is the very thing to 



GUARANTY OF BANK-DEPOSITS 95 

lower the quality of the assets. Of course, the insurance 
advocate will say that insurance will bring about safer 
banking methods; but of that more later on. 

The insurance theorists probably mean that their 
scheme would prevent a panic, because it would prevent 
a run on any bank in the system. One would be 
curious to know upon what analysis of credit opera- 
tions a crisis could be regarded as due merely to the 
state of mind which leads to a run for cash. In truth 
a run, a lack of confidence, is a consequence, not 
a cause, of panic conditions. It is a consequence of 
doubt as to the kind of business the banks have been 
doing; it is a consequence — as has already been in- 
sisted upon — of the poor quality of the assets. The ex- 
istence of a crisis and distrust comes from loading up 
with speculative ventures or assets which have lost their 
basis of market value. Extravagance, overconfidence, 
undue expansion of trade based on borrowing, prices 
raised to an undue height under a fictitious demand, 
speculation for rising prices of goods and stocks are* if 
wide-spread, the causes of panics. The sudden realiza- 
tion of this unsubstantial credit, when tested by some 
unexpected demand for liquidation, brings on a crisis. 
Every experienced man of affairs knows that the ma- 
terial for a financial catastrophe is collected by previous 
years of overtrading, and expansion of credit; and that 
it is only an accident whether it is this or that event 
which touches off the powder-magazine. The actual 
liquidation in the months following the panic of 1907 
shows upon what mistaken calculations many of our 
loans were based, and how rotten much of our credit 
fabric was. The Heinze-Morse affairs of October, 1907, 
were only one set of incidents in a series of existing weak- 
nesses, which had shown their appearance as early as the 



96 BANKING PROGRESS 

previous March. Now, when the assets in the loan item 
of the banks have only a fictitious value, when they lose 
their liquid quality, it is childish to talk about creating 
"confidence" by legislation, or by such a scheme as guar- 
anty of deposits. It would not change the previous ex- 
pansion of credit. A run is merely the logical sequence 
of what has gone before; and the evils of the past need 
time to be worked out. You may put salve on the spot 
kicked by a mule, but the salve cannot be said to have 
prevented the kick. 

In actual fact, if a bank has been soundly managed, 
if its assets are sound, a bank cannot fail, even if a run 
on it is started. "I have been forty years in the busi- 
ness," says one of the most successful bankers in this 
country, "and I cannot recall a single case of the failure 
of a sound bank that could be attributed to an unwar- 
ranted run on it by depositors. If its assets are good, 
it can always obtain cash, or assistance. If soundly 
managed, it will have reserves enough to meet any fool- 
ish run; or it could borrow on its convertible assets." 

Now, we have a right to ask, in what way could a 
scheme, which would lay the burdens of rash banking 
upon sound banking, stop a panic due to causes reaching 
back into the past ? As well say that a mustard poultice 
applied to a fever patient had prevented his having had 
any fever at all. The guaranty fund would, in fact, not 
check runs at all. Why? Because, even in case of a 
run, the guaranty fund could not be drawn upon until 
a bank had failed. Moreover, if there were a guaranty 
fund, and if runs were general, and many banks had 
failed, the main body of depositors could not get their 
cash immediately, but only after liquidation — sooner if 
assets were good, longer if assets were poor. Unless a 
fund exists large enough for immediate redemption of all 



GUARANTY OF BANK-DEPOSITS 97 

deposits of all failed banks in any serious crisis — an im- 
possible supposition, as we have shown — then the de- 
positor must know that some delay in drawing on the 
guaranty fund would be inevitable. If so, and if he is 
filled with a panicky desire to have his money at once, 
such a depositor will try to withdraw his funds just as 
certainly under the guaranty scheme as he would do it 
now. In brief, as a result of our analysis, the guaranty 
scheme is proved to be founded on a foolish theory ' of 
panics, and on an utter misunderstanding of the facts of 
trade and banking. 

§ 8. If the advocates of deposit-insurance are really 
in earnest in wishing to mitigate the effects of an un- 
reasoning run by depositors — after previous conditions 
have produced a crisis — let them carefully consider the 
reforms needed in our system of bank-note issues. When 
unfavorable developments, like the Heinze and Morse 
revelations, created a suspicion as to banking soundness, 
then suddenly psychological conditions appeared arising 
from alarm as to the safety of deposits. Would a guar- 
anty of deposits have been a rational cure for this fear? 
Let me explain briefly the situation which makes a run 
dangerous. In order to serve the public, the bank gives 
a borrower present means of payment in return for which 
the bank will get repayment by waiting until a time in 
the future. In reality, when the bank gives him a right to 
draw on demand, the whole risk as to the successful issue 
of the transaction falls on the bank; that is, the bank 
virtually insures the soundness of the business transac- 
tion on which the loan was based. Quite effectively, the 
banks convert the value of salable goods into a means of 
payment, and enable a borrower, by checks on a deposit- 
account, to exchange the value of his goods for other 



98 BANKING PROGRESS 

goods which he wishes to buy. Obviously, no one wishes 
cash, since he loses interest on it so long as it is in his 
possession. Hence, when affairs are normal, men do 
not ask for cash, and banks can easily keep the percentage 
required in the legal reserves. This explains why a bank 
may legitimately have $70,000,000 of demand-deposits, 
and yet perhaps keep only $18,000,000 of cash reserves. 
Now, under such conditions, what happens if the cus- 
tomers lose their heads, and all ask for cash ? Of course, 
all could not get it; and these customers, under an un- 
written law, became depositors knowing they could not 
get it. In spite of the superficial impression that a de- 
posit in a bank is cash, it is not so in reality; and it could 
never have been so "nominated in the bond," if wanted 
all at once. Nor could any conceivable guaranty fund 
be large enough to provide the cash at once. It is an 
utter impossibility. 

But, on the other hand, observe that the whole object 
intended by a guaranty of deposits could be gained by a 
safe and properly elastic note-issue — such as has been 
proposed in various currency reform bills. It would en- 
able the immediate exchange of a deposit-liability into a 
note-liability, without altering the relation of reserves to 
demand-liabilities, and yet retain for the notes the same 
assets as security which previously were regarded as safe 
for the deposits. Not only would this plan not diminish 
the power of the bank to lend, but it would save its re- 
serves of lawful money from being drawn upon, and thus 
even increase the ability to lend to needy borrowers. 
But it would do another very important thing: it would 
quiet the psychological conditions leading to runs, by 
enabling the bank to pay out its own obligations in a 
form of "money" which would satisfy the desire to 
hoard, and enable trust companies, and other institu- 



GUARANTY OF BANK-DEPOSITS 99 

tions, to be supplied with cash. If national banks, in 
the crisis of 1907, had been able to reduce demand-de- 
posits by increasing demand-notes, in the same propor- 
tion, they would have been able to meet the request for 
pay-rolls, and for the cash needed in ordinary retail 
trade, without having had practically to suspend pay- 
ment from the Atlantic to the Pacific. By providing 
notes, the banks would not have obliged business houses, 
as they did, because of the suspension in that crisis, to 
withhold their daily cash receipts and not deposit them 
in the banks. Moreover, if depositors could have ob- 
tained notes pro tanto, the newly born agitation for the 
guaranty of deposits would, in all probability, have never 
made any headway. In fact, the demand for a guaranty 
of deposits might have been directed into a thoughtful 
demand for a system of note-issues which would have 
effectively removed the difficulties under which depositors 
labor in the hours of a panic. 

Still further, it should be mentioned that these new 
note-issues should in no respect differ in color, design, 
security, or wording, from notes previously issued in 
normal times. In a crisis, or in the critical conditions 
preceding one, or in any emergency of the money market, 
it should not be necessary to go out with a brass band to 
inform the public that it was quite time to get into a 
panic because special emergency notes were about to be 
issued. 

In times of stress, however, the depositor's need is not 
the most important; for if he has a deposit he can pay 
a debt by a check. We must consider, in this matter, 
not the banks, but the great business public who need 
help. The fundamental need is the grant of a loan, or 
the continuation of an old one, which gives the right to 
draw on a deposit. In a panic men are driven to liqui- 



100 BANKING PROGRESS 

date, to throw over securities to meet maturing obliga- 
tions. A loan is the protection from ruin. If legitimate 
borrowers can get loans, the worst is over. It is need- 
less to say that a guaranty of deposits does not in any 
way affect the ability of a bank to lend in a time of panic; 
therefore, it will have no appreciable influence in reliev- 
ing the conditions brought on by a collapse of credit. 
The only thing that it can do, at the best, is to save the 
depositor from waiting for his funds during the time of 
liquidation; and even this purpose is now abandoned by 
insurance advocates as impossible. The real alarm — 
and the one which needs to be quieted — is that based on 
questions as to the value and character of the assets of 
the bank; and that depends upon the whole manage- 
ment in a time reaching back into the past. 

§ 9. The plan for insurance of deposits is urged by 
its advocates as one which will induce more careful bank- 
ing, because contributors to the fund will be more vigilant 
in acting as policeman over other bankers, and stop 
illegitimate methods in their inception. On the other 
hand, its opponents claim that it will reduce the best- 
managed to the level of the worst-managed banks, and 
remove all premium on skill, honesty, and ability. 

Apart from fraud and stealing, what is bad banking? 
Clearly, it is the lending of too much to favored, or in- 
side, parties; and the inability to know good from bad 
paper, and "quick" from tied-up investments. Every 
conceivable reward should exist to bring pressure on a 
banker to have courage in declining questionable loans. 
The moment such pressure is removed, the opportunity 
is enlarged for taking on assets, which, at the first real 
emergency, will crumble in value, and leave the deposi- 
tors unsecured even after long and difficult liquidation. 
Therefore, to relieve the banker from the logical conse- 



GUARANTY OF BANK-DEPOSITS 101 

quences of his own mistakes, of his own weaknesses, is 
to take away practically the only real safeguard likely to 
affect human nature in a business touching the trusts of 
countless financial interests. The result of such a guar- 
anty would, in my opinion, tend to put a premium on 
the "popular" and "obliging" banker, as against the 
careful and judicious banker; to spread throughout the 
country the influence of men who care more for bigness 
than for safety in their accounts; to build up credit un- 
supported by legitimate trade; and in the end to bring 
on financial convulsions proportional in disaster to the 
extent of the doubtful banking. Not only would it be 
unjust to ask the efficient to meet the losses of the ineffi- 
cient, but it is poor policy to expect the inefficient to do 
that for which they are unfit. 

An essential difference between banks in manage- 
ment, stability, conservatism, and success cannot wisely 
or justly be wiped out, without losing the very elements 
of safety and permanence in our business relations. A 
great bank with a large capital and surplus affords a 
wider margin of safety to deposits than can be afforded 
by a small bank; and the large bank will draw deposits 
for these very reasons. Moreover, depositors in prac- 
tice keep their deposits where they are likely to be able 
to get loans from time to time; and an examination of 
figures in any commercial bank would probably show 
that, during any given season, some large depositors had 
been owing the bank about as much in the form of loans 
as the bank was owing the depositors. In that case, in 
order to treat both sides fairly, would it not be just to 
ask the depositors also to insure the banks against loss 
from loans? In fact, if the argument for insurance of 
deposits has any validity, then the same system, in order 
to treat both interests in question with equal justice, 
should be extended by a tax on all borrowers to insure 



102 BANKING PROGRESS 

the bank against loss from unfortunate loans. If this 
were done there would be no need of guaranteeing de- 
posits; for if assets were safe, deposits would be safe. 
Indeed, too much is claimed for this guaranty of deposits. 
All the gains of society are credited to it, until one is in- 
clined to think its advocates see in it a remedy for all 
the imperfections of man. 

We have previously explained that a guaranty system 
would promote bad banking, but the advocates go to 
the length of asserting that it would positively discourage 
reckless banking. In what manner is it thought it would 
discourage the making of bad loans? By proposing to 
watch the paper offered to banks? Not at all. What, 
then, is the argument for this pure theory ? "Under this 
plan of securing the depositor," says Mr. Bryan, "the 
stockholder loses all that he has before any other bank 
loses anything. Not only does he lose all his stock, he 
also loses the penalty that the law fixes, and the loss of 
the stock and the penalty are enough to make him exer- 
cise care." Is it possible that Mr. Bryan does not know 
that under existing law every bank must itself first lose 
all its capital, surplus, undivided profits, and stockhold- 
ers' liability, if it is guilty of gross mismanagement, be- 
fore the depositor loses ? * Then, from Mr. Bryan's 
point of view, just as things are to-day, we have all the 
conditions to insure vigilance just as well as if we had 
the much- vaunted guaranty of deposits. The only feasi- 
ble guaranty system is now in actual use. 

Let us further analyze the practical working of this 
matter. Suppose a bank accepts the theory of its ad- 
vocates that the guaranty of deposits will prevent all 
runs; that, since the depositor is wholly protected, he 
will not withdraw his funds in a crisis. Obviously a plan 
which makes the banker think there will be no demand 

1 See Chapter VI, § 3. 



GUARANTY OF BANK-DEPOSITS 103 

for cash reserves in a panic will take away the necessity 
of forcing him to carry only such assets as are quickly 
and surely convertible into cash in an emergency. Under 
this scheme there will be no need of having good assets to 
offer to outside banks for assistance when hard pressed. 
Thus, from another direction we reach the conclusion 
that the plan will remove the safeguards against reckless 
banking. 

Since the guaranty of deposits will not prevent the 
materials for a crisis gathering; since it will not advance 
sound banking methods; since it is unjust to legitimate 
bankers, and since all the benefits to be gained by it 
can be secured by a proper note-issue (which would miti- 
gate runs), or by better methods of banking, there is no 
great reason for going into a scheme which is as distinctly 
socialistic as this one. Moreover, among the means 
within our reach for securing better banking is the im- 
provement of national bank inspections. Appointments 
as inspectors have been made largely for political, and 
not for expert, qualifications; nor are the fees, assign- 
ments, and frequency of examinations what they should 
be. The clearing-house associations, in default of proper 
national inspections, and also to aid in legitimate bank- 
ing by State banks and the trust companies clearing 
through their associations, established inspection agencies 
of their own, which have proved remarkably efficient in 
securing safety to the community from failures. Such 
action is worth all the guaranty schemes ever born in 
giving protection to depositors, and it is done in the only 
businesslike way practicable. The example set by the 
Clearing-House Association of Chicago, after the Walsh 
failure, has been followed in other cities. 

§ 10. It is said that, as we have insurance for plate 
glass, for houses, and for life, we can rightly have insur- 



104 BANKING PROGRESS 

ance for deposits. That is clear: we agree. In life in- 
surance the man whose life is insured pays the premium; 
he never asks his neighbor, who is not insured, to pay 
his premium for him. So, to make the case parallel, the 
depositor should pay the premium. That is a business, 
not a political, proposal. If so, companies insuring de- 
posits would charge a high rate for deposits in badly 
managed banks and a low rate in well-managed banks. 
That would very soon separate the sheep from the goats. 

When examined from the point of view of technical 
insurance principles, the guaranty method is not impos- 
sible of treatment for the hazard incurred. Any uncer- 
tainty can be insured, provided the premium is large 
enough. It is said that companies already exist ready 
to insure deposits at yi of 1 per cent; but they evi- 
dently expect to choose the banks. And just here 
arises the central difficulty. In ordinary fire insurance, 
one enters it voluntarily; and one gets a different rate 
according to differences in the moral and physical hazard. 
Yet in the guaranty of deposits all banks irrespective of 
differences in management are forced to enter the scheme. 
If a group of banks of high standing voluntarily chose 
to insure each other's deposits, because they had con- 
fidence in each other's management, that would be a 
different thing from the plan generally proposed. More- 
over, the parallel with fire insurance, in which the owners 
of the property at risk pay the premium, and the insur- 
ance of deposits, in which the depositor does not pay the 
premium, does not hold. As a strictly insurance question, 
it should be left to the insurance companies and the de- 
positors. This was practically the outcome reached by 
the Kansas legislature, which, following the radical action 
of Oklahoma, established a guaranty of deposits by 
State law. 

If the guaranty is desired for the immediate redemption 



GUARANTY OF BANK-DEPOSITS 105 

of all deposits in failed banks in any crisis, a very large 
fund in cash would be required. For deposits in national 
banks alone, a 5 per cent fund would be about $216,000,- 
000 — a sum too large to be allowed to lie idle in cash. If 
invested in bonds, it can no longer be regarded as availa- 
ble for immediate redemption. In fact, the aim of im- 
mediate redemption, as already said, seems to have been 
dropped. If, on the other hand, the guaranty is intended 
only for ultimate redemption, after the bank's assets have 
been liquidated, it will not materially change existing 
conditions, and will not give ardent advocates of deposit- 
insurance what they are clamoring for — the immediate 
control of their funds in failed banks. Of course, it 
might be said that, if ultimate redemption were assured, 
deposit-accounts in failed banks would become negotiable, 
like any other delayed payments. But the same is true 
now: the accounts in the suspended Knickerbocker 
Trust Company of New York were bought and sold in 
1907; and the price should properly vary with the time 
of discount and the risks involved. The average annual 
losses to depositors in national banks, after complete 
liquidation, have been remarkably small, or only y 20 of 1 
per cent for forty-three years. This fact has been used 
to prove how small the guaranty fund need be. But if 
ultimate redemption is accomplished with such little 
loss, there is not so great a need for a fund as supposed. 
The error of the insurance theorists is in confusing ulti- 
mate with immediate redemption, and arguing that if a 
small fund is needed for the former, the latter can be as 
easily provided for. The mistake is patent. 

§ 11. Finally, the appeal to history gives the plan no 
authority. We have had experience with a guaranty of 
deposits in New York under the Safety Fund Act, of 
April 2, 1829. The conditions of the country and the 



106 BANKING PROGRESS 

understanding of banking were such at that time that 
the lessons from that experiment cannot have very much 
value. There was then held only one reserve for both 
notes and deposits. Expansion of loans in those days 
meant, in the main, an expansion of notes. The safety 
fund was, therefore, a protection to both notes and de- 
posits, but mainly to notes; as business, however, was 
then largely done by notes, its service was much as 
would be rendered to-day by a guaranty of deposits. 
What then was the outcome ? The fund was established 
by levying a tax of Yi of 1 per cent on the capital stock, 
until a fund of 3 per cent was reached. After eight years 
the fund was tested by the crisis of 1837, when there 
were ninety banks in operation with a capital of $32,200,- 
000. All the banks stopped payment, and the act itself 
was suspended for a year. Again, in 1840-1842, the 
system was put to the test by eleven serious bank failures. 
Thereupon, in 1842, it was decreed that the fund should 
hereafter be used only for the redemption of the notes of 
failed banks. The experience of Vermont and Michigan 
was still less satisfactory. In brief, as a guaranty of 
deposits such a fund proved a signal failure — although 
the experiment, as I have said, is not conclusive for 
present conditions. 



CHAPTER VI 

THE DEPOSITOR AND THE BANK 

§ 1. All bankers ought to welcome the discussion 
caused by the proposal to guaranty deposits, because 
it will inevitably bring out a better understanding of the 
vital functions of banking and better explain the true ser- 
vices of banks to the community. All that bankers can 
desire is the truth about their business. It is undoubt- 
edly clear that the reason for there being any question 
at all to discuss exists in the misunderstanding in certain 
quarters as to what banks really do, and as to what is 
essential to sound banking and the safety of depositors. 
There can be a wish only for a fair field and a full dis- 
cussion. 

The argument in favor of insuring deposits is ad- 
dressed to two classes: (1) the depositors, and (2) the 
bankers and stockholders in banks. In this order we 
shall further discuss the subject. 

It is said that it is the depositor who makes banking 
profitable. Here appears a misconception as to the 
banking business. In reality, deposits are only the raw 
materials for profits; they must be wisely and skilfully 
managed or there would be, not only no profits, but even 
losses. To have a profitable result, we need skilled labor 
to work up the raw materials, not only in industry, but 
in banking. The mere existence of capital does not in- 
sure profits; everything depends upon what is done with 
the capital. Capital is often badly invested and lost. 
In banking, we shall see that practically everything de- 
pends upon wise, honest, and capable management. 

107 



108 BANKING PROGRESS 

Moreover, since the days of the Bank of Venice, banks 
have come into existence as a means of satisfying a need 
of the business public. Persons deposit in banks volun- 
tarily because they get privileges in return: sometimes 
interest on deposits; collection of checks deposited; a 
chance to get loans where deposits are kept; and, above 
all, to share in the most convenient, least expensive, and 
most generally used medium of exchange ever devised, 
by which payments can be made anywhere in the land 
through checks drawn on a private account; and all the 
expense of this bookkeeping is usually given free to the 
depositor. All the monetary services of the general 
government, all the issues of every kind of paper money, 
do not begin to compare with the service rendered to the 
public by the work of exchanging goods done by the banks 
and clearing-houses through checks drawn by depositors 
on their accounts. Take that away from the depositors 
for twenty-four hours, and the whole trade of the coun- 
try would be paralyzed; and yet there are persons who 
say that depositors are not given anything in return by 
the banks. 

§ 2. But the misunderstanding of commercial bank- 
ing shown by the advocates of a guaranty of deposits 
goes still further, when they demand such a guaranty on 
the ground of justice to depositors: that they ought to 
have a place wherein they could leave money and get it 
again whenever they want it. Now, if a depositor wishes 
none of the privileges of a checking account in a com- 
mercial bank, he can put his money in a safety-vault, and 
get it again whenever he wants it. In a commercial bank, 
on the other hand, it is never pretended that if all de- 
positors wanted their money at any given moment all 
could get it. Why? Because a commercial bank could 



THE DEPOSITOR AND THE BANK 109 

not exist if it did not invest a large part of the funds de- 
posited with it. It creates demand-liabilities to an 
amount equal to all its deposits, but it tries to have 
paper maturing in such a continuous way that it can 
meet all normal demands for cash. A solvent bank can 
always meet cash demands if given suitable notice of 
what is coming. Yet the agitator, who does not seem 
to know the difference between a safety-vault and a 
commercial bank, asks for what is humanly impossible 
— as a matter of justice. He asks that banks should 
receive the deposit, but in the same breath he assumes 
that they should never do anything with it. Justice is 
assured when, and only when, the banks invest in sound 
assets; and all depositors can secure their funds only 
when the management is successful, cautious, and con- 
servative. The deposits, in short, are as safe as the 
assets are good; and the sum and substance of the 
whole matter is to be found in the character of the 
management. We come back to this truth from what- 
ever point we begin our researches. 

I have said that the safety of the deposits depends 
upon what is done with them. A considerable part of 
the deposits, as is well known, are loaned out. Now, if 
you could force all the borrowers of a bank to insure 
that bank against losses from bad loans, you would give 
both the bank and the depositor absolute safety. But 
if the borrower of good credit declines to be responsible 
for the borrower of poor credit, you cannot blame the 
safe banker for refusing to be responsible for the specula- 
tive banker. 

Yet it may be said that commercial banks have a 
quasi-public function; that depositors are innocent of 
the inside doings of banks; that when the banks in- 
vest deposits they put them out of reach of the de- 



110 BANKING PROGRESS 

positor; and that too much is asked when the depositor 
is required to trust to the soundness of the investing 
judgment of bank officials. It is further added that when 
the authorities of a government, State, or city deposit 
with banks, some special security for the deposit is 
given; and that if a bank exacts security from the bor- 
rower, the bank should give security to ;the depositor. 
If a State or city exacts security for its deposits, it is 
the subject of a special contract between the depositor 
and the bank in which the deposit is made. If a private 
depositor wishes to make a similar special arrangement 
with a bank, he can do so. But now mark just where 
the guaranty advocates miss the point. They are not 
urging that each bank should guaranty its own de- 
positors, but that a sound bank should guaranty de- 
positors that it never heard of, in a bank over whose 
management it has never had the slightest control. 
That is unjust. It is near to robbery. To this case is 
joined the proposition that the very existence of banks 
organized under a national act gives a presumption to 
the trustful public that such banks are sound; and, if 
so, the government should see to it that the depositors 
are made absolutely safe. 

§ 3. In serious fashion let us look this case squarely 
in the face. Apart from the great privileges given by 
the banks to depositors — already described — do the 
banks recognize the fact of their quasi-public function, 
and that they must give security to their own depositors 
for exercising good judgment in making loans, with the 
knowledge that the stockholders will suffer a heavy loss 
in case of error or fraud ? The answer unequivocally is, 
they do. In fact, the lapse disclosed by the advocates 
of insurance of deposits in no part of their argument ap- 
pears more obvious than in not knowing that the banks 



THE DEPOSITOR AND THE BANK 111 

now put up a very large fund as a security for their de- 
positors. 

There are only two possible ways of using a guaranty 
fund: either for (a) ultimate, or for (b) immediate re- 
demption of deposits. Let us consider ultimate redemp- 
tion first on the assumption that a guaranty of de- 
posits should be urged on national banks. Is it con- 
ceivable that the political orators do not know that 
there is already a guaranty fund for the ultimate pay- 
ment of deposits ? The capital, surplus, and undivided 
profits of every national bank is the buffer between the 
depositor and loss. Only after the mis judgment of a 
bank has destroyed its capital, surplus, profits, and 
shareholders' liability can the depositor suffer loss. Is 
this effective, in fact ? That it is effective is disclosed by 
the figures, quoted even by the guaranty advocates, 
that the loss to depositors in over forty years of the 
national bank system is only Ke of 1 per cent per annum. 
Here, then, we have final and complete proof that the 
banks actually do insure their depositors at the risk of 
great loss to themselves. On May 14, 1908, the amount 
of this ultimate guaranty fund was as follows, for the 
6,778 national banks: 



Capital $912,361,919.59 

Surplus 555,000,248.14 

Undivided profits 203,108,414.78 

Stockholders' liability 1 273,000,000.00 



Total $1,943,470,582.51 



Although the shareholders' liability is legally equal to the capital stock 
held ($912,361,919.59), yet it is well known that actual collections fall .short 
of the legal total. Shareholders may have no other attachable property than 
their shares. The aggregate capital of insolvent banks, finally liquidated, 
was $59,622,420; assessments levied, $36,246,390; collections from assess- 
ments, $17,616,404. Thus the percentage of actual collections to capital 
was, in round numbers, about 30 per cent. Cf. Table 73, Report of the Comp- 
troller of the Currency, 1907. The figures for this year are typical and serve 
as well as those for any later years to illustrate the principle. 



112 BANKING PROGRESS 

Omitting deposits in the national banks by the govern- 
ment and disbursing officers to the amount of about 
$180,000,000, which were covered by bonds, the private 
deposits amounted, at the same date, to $4,313,656,789.59. 
Therefore, the insurance fund for all the banks amounted 
to about 45 per cent of all the private deposits. This 
shows, of course, that when a depositor is considering 
the selection of an individual bank in which to deposit, 
he gets a larger security, other things being equal, from 
those having the largest capital, surplus, and undivided 
profits. 

But, an objector may say, the banks themselves keep 
this fund in their own hands and invest it just as they do 
deposits. Of course they do; but even if there were a 
shrinkage of 50 per cent in the assets there would on 
liquidation still remain a cash fund of about $1,000,000,- 
000, or more than twenty times as large as any sum pro- 
posed by the advocates of a guaranty fund. It is all 
available for the ultimate liquidation of deposits. More- 
over, in Oklahoma, the State redeposited the guaranty 
fund with the banks. 

§ 4. Next, let us consider (6) immediate redemption. 
No one has gone to such an extreme as to propose the 
segregation of a fund large enough for the immediate re- 
demption of all deposits. In fact, the withdrawal of 
any large sum — even 5 per cent of deposits — from the 
banks to any depository, where it would remain un- 
invested, is purely chimerical; and, if invested in bonds, 
it would be of no use as a cash fund for instant use. 

Immediate redemption in cash is impossible, in any 
serious crisis, because cash is, by the very nature of a 
crisis, out of reach. In the panic of 1907, the closed 
banks in New York alone, as has been before mentioned, 



THE DEPOSITOR AND THE BANK 113 

had deposits of about $100,000,000. During that panic, 
where in this country could that sum in cash have been 
obtained ? And this says nothing of the closed banks at 
that time in the rest of the country. Even the Treasury 
of the United States did not have enough. In fact, it 
was itself in a panic and planning to get the banks to 
come to its aid when duties fell off. 

If other than the failed banks — the latter having been 
badly managed — had been called upon, when the needy 
business public were pressing them for loans, to put up 
this cash out of their own resources — in addition to the 
demands from country banks in the interior — the panic 
would have spread destruction far and wide. Such a 
guaranty system would have aggravated every evil. 
That is, just when sound banks were stretching every 
nerve to save legitimate business concerns, they would 
have had their reserves reduced enormously, solely to 
cover the mistakes of unsound banks for whose conduct 
they could in no sense be held responsible. 

§ 5. In view of the small loss to depositors in over 
forty years of the national bank system — as if that 
were not in itself a complete answer to their argument — 
the advocates of a guaranty fund showed a further mis- 
conception as to banking operations by saying: If this 
loss is so small, why not go further and give us absolute 
security ? 

As if anything in human affairs is capable of absolute 
certainty. Men are not yet perfect; and mistakes may 
be made in our judgments as to the outcome, not only of 
business, but even of political expectations. A bank does 
business with fallible human beings. A borrower of a 
bank, when in the midst of important operations, may 
die; or a house borrowing of a bank may have an em- 



114 BANKING PROGRESS 

bezzling official and be crippled; or a general financial 
depression may unexpectedly cut off collections and oblige 
banks to continue loans rather than force failures — and 
yet, in view of all these things, the banks are asked to 
give absolute security. Why not ask a clergyman on 
becoming a pastor of a church to give absolute security 
that no one in his flock will ever tell a lie, commit an error 
in conduct, or go to hell-fire ? Why not make the doctors 
give a guaranty that no patient shall ever die? 

Banks, or any other business enterprise, cannot promise 
absolute security. Take the case of a steamship company. 
It requires cash, or security, for tickets from its passengers; 
yet it cannot possibly give absolute security to them. 
It does a transporting business dealing with uncertain 
elements in nature and human beings; it can only do its 
best in overcoming the dangers of the sea with the best 
obtainable seamanship and good management. The pas- 
sengers on a steamer and the owners of the steamer are 
equally interested in not having the steamer sink. Even 
then, in spite of every precaution, there are losses. So 
it is with banks. There are inevitable risks involved in 
lending idle funds deposited in banks to the active men 
who use them in productive industry. There always 
will be risks, so long as men are fallible. That manage- 
ment is best which makes the least mistakes. If absolute 
security is required, commercial banks must become 
safety-deposit vaults. There is no other alternative. 

§ 6. Thus far we have taken up the arguments in 
favor of guaranty of deposits addressed specifically to 
the depositors, as if they were at present not receiving 
their rights; and we have shown these arguments to be 
based on a misconception of banking and business opera- 
tions. Now, we may next pass to the points addressed 



THE DEPOSITOR AND THE BANK 115 

directly to the self-interest of the bankers themselves, in 
order to make them favor a guaranty. 

As is well known, the scheme to insure deposits re- 
quires all banks, good and bad, jointly to contribute to 
a fund to pay off depositors in failed institutions. The 
more successful the bank, the larger its deposits, the 
more it must pay into the fund; the less successful a 
bank is in impressing the public with its security and 
the smaller its deposits, the less it pays into the fund. 
The successful are to pay for the mismanagement of the 
unsuccessful. Let us illustrate. If burglar A robs B's 
house, go to the most honest man in the village, C, and 
rob him to pay for B's loss— it will increase the eager- 
ness of all men to be honest and discourage burglary ! 
C, the successful man, will enjoy paying for B's care- 
lessness in keeping no locks on his house; and if C has 
to pay for all the deviltry in the town it will stimulate 
others to get honest so that they can pay for similar 
losses. As C, who had nothing to do with the case, is 
penalized, and not A, the burglar, the plan will discourage 
burglary. The scheme is perfect; it might work per- 
fectly — in an insane asylum. Mr. Bryan has well said, 
and we must all agree with him: "One of the things I 
want to see adopted in the form of regulation [of banks] 
in the near future is the law that will put the penalty on 
the right man and not on the community." If the Eng- 
lish language conveys its meaning clearly, those words 
mean that he favors penalizing the man who cheated his 
depositor by bad loans and not the man who protected 
his depositor by safe loans. If that is the case, it is 
only logical to suppose that Mr. Bryan was radically op- 
posed to the guaranty of deposits. 

But, say the guaranty theorists, depositors really suf- 
fer from bank failures; and the only way to prevent this 



116 BANKING PROGRESS 

suffering is to make such a combination of all banks as 
will force the good banks to watch the bad banks, know- 
ing that the good banks must pay the losses unless they 
prevent failures. A combination of this kind is not, of 
course, founded on equality and co-operation. It is a 
plan by which the depositor, in case he makes a mistake 
in choosing his bank, will have an innocent bank pull 
the chestnuts out of the fire for him. Of course the 
sound, well-managed bank would never draw on the 
fund; it is put up solely for the weak ones. 

Let us for a moment analyze the theory that the guar- 
anty of deposits would oblige the sound banks to watch 
the unsound ones, and thus cause better banking. Is it 
possible for good banks to prevent other banks from 
making bad loans ? The fact that a bank is doing ques- 
tionable banking is known only after loans are made. 
Then, how can you prevent the initial act? Obviously, 
only by establishing a central organization of the best 
bankers who should pass on every application for credit 
before it is given by other and smaller banks. But that 
is impossible, visionary. Such a remedy would be re- 
garded by the smaller bankers as worse than the disease. 
It would be like creating a trust, or a "money octopus." 
In providing what is an impossible remedy for depositors 
in time of failure, it would amount to creating a means 
which would really destroy existing credit facilities. If 
mice trouble the housekeeper, you would not, in the hope 
of killing the mice, import a tiger that would devour the 
very housekeeper herself. 

In truth, the only way to control the initial act of each 
bank when making a loan is by increasing in every pos- 
sible way the rewards to sound and conservative bank- 
ing. It cannot be done by saying that, if bad loans are 
made, the penalty for them shall fall, not on the unwise 



THE DEPOSITOR AND THE BANK 117 

banker who made them, but on the innocent and wise 
bankers who had nothing whatever to do with the bad 
loans. That is dangerous political, as well as banking, 
morals. If good management is made to pay for the 
evils of bad management, there will be taken away the 
rewards for sound banking and all reason for the growth 
of skill and integrity. To suggest that sound banks 
should pay the customers of unsound banks in cases of 
failure puts the responsibility and penalty on the wrong 
persons, and violates every principle of justice and fair- 
ness between men. 

Every banker knows that a bank permanently gains 
deposits only by impressing the business public with a 
belief in its influential connections, in its foresight in 
meeting financial emergencies, and in its wise and skilful 
management. The depositor is properly influenced by 
these considerations. But under a scheme of guaran- 
teeing deposits, what would be the effect? 

Bankers of doubtful judgment and integrity would 
find themselves relying on the guaranty fund (supplied 
mainly by other banks) as a means of attracting deposits, 
instead of trying to attract them by the exercise of skil- 
ful management. As a result, the deposits of the coun- 
try would be changed from a method of distribution 
based as now on relative estimates of wise management, 
to another and artificial method in which soundness of 
management would play no part. Under this false system 
deposits would inevitably be got by those who are less 
skilled and honest than those who now hold them. That 
is exactly what the plan is contrived to do. The funda- 
mental mischief in the scheme is that it is based on the 
theory that all men in the banking business are equally 
honest and efficient. A theory based on such an error 
can never be supported by any but specious arguments. 



118 BANKING PROGRESS 

The appeal is sometimes made to small banks that a 
compulsory insurance fund including all banks, large and 
small, will put the small on the same level as the large 
banks, so far as accumulating deposits is concerned. In 
brief, it is an appeal to select a bank, not on the strength 
of its management, but on the fact that bad management 
will be paid for by "the other fellow." That is, banks 
willing to accept this appeal are by that very fact to be 
distrusted; for they are soliciting business on the theory 
that they are to be trusted not because of their sound 
banking, but because of a system under which they can 
escape due responsibility for losses. Bankers who would 
advertise an insurance fund to attract deposits obviously 
advertise the fact that they do not expect to receive de- 
posits primarily on their record as careful bankers. 

The guaranty theorists even insist that successful 
banks now oppose an insurance law, because they wish 
to take advantage of the insecurity of badly managed 
banks, and to draw deposits away from them. Of course 
they do. Why not? Should not an honest man glory 
in his honesty and deserve the rewards which the com- 
munity deal out to honesty? Does not an honest and 
upright lawyer win a larger practice over an incompetent 
shyster for exactly those reasons? 

§ 7. As an example of what has just been explained, 
we have the Oklahoma experiment. Some of the banks 
of this State sent out cards showing the increase of their 
deposits. Two causes were supposed to be at work: 
(1) the cessation of hoarding, and (2) the relatively supe- 
rior safety of Oklahoma banks, as contrasted with those 
having no insurance deposits. As regards the first cause 
(1), there was no evidence whatever but general opinion 
regarding the amount of money hoarded and the amount 



THE DEPOSITOR AND THE BANK 119 

that came out of hoards. The very word "hoarding" 
implies secrecy and the absence of knowledge about 
sums or places. But the rapid movement of men and 
capital to the exceptional resources of an undeveloped 
region was in itself enough to account for increasing 
deposits. 

As regards the second cause (2), doubtless some minds 
were influenced by the existence of a guaranty. One 
speaker exulted over the case of an Illinois man who 
withdrew $6,000 from an Illinois bank and deposited it 
in one in Oklahoma in order to be more safe. Under any 
system, however, there are good and bad banks. No 
doubt there were some banks in Illinois to be distrusted; 
and the sound Illinois banks would not wish to be held 
responsible for them. And the same was true, of course, 
of Oklahoma. If a guaranty system will prevent bank 
failures, why is it that already in Oklahoma failures have 
taken place ? Of course there is nothing whatever in 
the claim, so sensationally put forth, that a guaranty of 
deposits will prevent failures. There will be good and 
bad banking in Oklahoma under a guaranty system. If 
it were not certain that there would be bad banking there, 
then why was the act passed ? Solely to make the good 
pay for the bad. No legislation will make every banker 
in Oklahoma, or anywhere else, honest and skilful. 
Some are certain to be weak and inefficient under any 
system. The whole question is: Who shall pay for their 
mistakes? Obviously, we all agree with Mr. Bryan in 
insisting that the penalty shall be put "on the right man 
and not on the community." The "right man" is clearly 
not the man who has won success in gathering deposits 
by the exercise of honor and discretion in his business. 
And no amount of special pleading can induce us to put 
the penalty on him. But the guaranty of deposits is, 



120 BANKING PROGRESS 

by its very nature, intended to put the penalty on him. 
And, finally, the attorney-general has ruled that national 
banks cannot go into the business of insuring other bank- 
ers, since it is a business foreign to their banking charters. 
Consequently a ruling in accordance with that opinion 
has been made by the comptroller of the currency. 1 It 
is for the depositor, not the bank, to seek an insurance 
company chartered to take such risks. 

§ 8. Not having any substantial basis in knowledge 
of proper banking operations, the guaranty scheme has 
been ingeniously urged upon bankers because of the 
peculiar relations of national banks to State banks. Of 
course a federal law would not cover the action of State 
banks, and vice versa. Now it is proposed to urge the 
federal guaranty law on the ground that, in any one 
State, such as Oklahoma, Kansas, or Nebraska, a State 
guaranty law would force the national banks to come 
in or lose their deposits. Hence, the only way to pro- 
tect the national banking system against the encroach- 
ments of one or several States is to pass a federal law for 
a guaranty of all national bank depositors. 

(1) Suppose a national guaranty law were passed. 
Then, on the theory of its advocates, the deposits would 
leave the banks in all States having no guaranty law 
and go to the national banks. In that case, the law would 
work an injury to every honest State bank. Obviously, 
then, the State bankers ought to be opposed to the 
scheme, so far as their interests are affected. But, say 
the guaranty theorists, in that case every State would 
be obliged to pass a guaranty law also. If that fol- 

1 For further information on the Oklahoma and other experiments, see 
Thornton Cooke, Quarterly Journal of Economics, November, 1909, and Feb- 
ruary, 1910; and The Guarantee of Bank Deposits, by T. Bruce Robb, soon to be 
published (1920). 



THE DEPOSITOR AND THE BANK 121 

lowed, of course the State and national banks would 
stand relatively to each other just where they do now; 
and there would be no gain to any bank in either class. 
The result would be nil, except that good banks, both 
State and national, would now have to carry the losses 
of bad banks. 

But (2) suppose some States, like Oklahoma, Texas, 
Kansas, and Nebraska adopted a guaranty system. 
Then other States, having a more just view of their duty 
to careful banking, might not adopt it. As a conse- 
quence we should have as endless a confusion as exists 
now, for instance, between State bankruptcy laws. 
Hence, are clear-headed business men in other States, 
with their eyes open, likely to urge a law certain to create 
a confusion in business relations with correspondents in 
different States compared with which present conditions 
would be like paradise ? I think not. 

In order to force bankers to accept a guaranty law, 
however, a threat had been made that, if they did not, 
they must expect a postal savings law. Here the argu- 
ment was addressed to the fear of losing deposits. Those 
who thought this threat formidable obviously failed to 
distinguish between a savings-bank and a commercial 
bank. The adoption of a postal savings law affected, in 
the main, only the uninformed small depositors who hoard, 
or who distrust the local savings-bank. In the nature of 
things such a system could not attract the large mass of 
deposits left with the commercial banks by active busi- 
ness men, for one overwhelming reason. A true com- 
mercial bank exercises both the functions of deposit and 
discount— the issue-function not being essential. Now, 
if a depositor is in trade, or if he is one who may need 
loans, he is by that fact estopped from keeping his funds 
with a government postal agency, from which he cannot 



122 BANKING PROGRESS 

borrow on short time. Exactly because the government 
is not a bank, and ought not to be, it will not receive the 
checking accounts which are generally left with banks 
on the understanding that credit will be given when 
needed. 

Therefore, when a guaranty advocate rises to a rhetori- 
cal climax by threatening the banks not only with the 
loss of small savings-accounts — which are not profitable 
to a bank, anyway — but also the probable extension of the 
savings-deposit limit from a beginning at $500 to a higher 
limit, which would include the checking accounts of 
merchants, he is not likely to carry conviction. 

§ 9. Finally, the worst monetary fallacy in the argu- 
ments of the guaranty theorists is involved in the claim 
that, if established, the system would draw so much 
money into the banks as to remove all necessity for cre- 
ating an emergency note circulation. The error here is 
in confusing property, or goods, with the medium of ex- 
change by which the goods are exchanged. No matter 
how much actual coin is hoarded, no matter the cause 
which brings it out into bank reserves — the actual de- 
posits then require only the usual proportion of reserves; 
and when the banks reach that proportion, extra coin 
is disposed of just as quickly as a farmer sells his surplus 
wheat. After that, banking goes on just as before the 
arrival of the hoard. But what next? If a panic ap- 
pears next, there would be, as a consequence, just the 
same demand — be it more or less — for an elastic emer- 
gency circulation after the establishment of a guaranty 
system as there would have been before. An emergency 
in business conditions due to an overexpansion of credit 
will come and go for reasons entirely dissociated with the 
insurance of deposits — that is, if we may suppose that 



THE DEPOSITOR AND THE BANK 123 

human nature as it now acts remains the same after such a 
system is put into operation. In fact, the idea that the 
quantity of money in existence is of chief importance, as 
distinct from the quantity of salable goods on which loans 
and deposits are based, is but the old greenback fallacy in 
a new disguise. It overlooks the clear truth that as sala- 
ble goods increase there is increased the basis for legit- 
imate loans by banks ; that these loans result in deposits 
on which checks are drawn; and that thus the banks 
are constantly affording a deposit-currency to the public 
as an elastic medium of exchange. Let those who think 
an elastic and enlarging currency is desirable begin to be 
grateful to the marvellous service rendered by the de- 
posit-currency of the banks in exchanging over $250,000,- 
000,000 of goods every year. Greenbacks, and even 
bank-notes, are far behind in this comparison of work 
done by our different media of exchange. 



CHAPTER VII 

BANK-NOTES AND LENDING POWER 1 

§ 1. In the panic of 1907 it was impressed on the 
public and on Congress that our monetary system was 
not of the kind that could successfully withstand the 
stress of a monetary stringency or the greater dangers 
of a serious financial collapse. These impressions led 
to a wide-spread demand for monetary reform, to the 
appointment by Congress of the National Monetary 
Commission (1908), and to the publication by this com- 
mission of a great mass of material on money and bank- 
ing. These volumes may have helped in the education 
of Congress, but because of their bulk they were not 
likely to help very much in the education of the public. 
It is clear, however, from these volumes and from knowl- 
edge previously in our possession that the lessons to be 
had from other countries as well as from our own must 
inevitably be drawn upon in framing concrete proposals 
to Congress. Moreover, under our political methods, it 
was not a question as to what outside experts might pro- 
pose, but what the leaders in Congress thought could be 
passed through both Houses under the existing conditions 
of public opinion (educated, of course, as far as possible). 
This situation we have had to keep in mind in all our 
discussions. The lessons to be got out of these volumes 
and the inferences from them applicable to conditions 
in the United States could without doubt be very simply 

1 This chapter may have some interest due to the fact that it was written in 
November, 1910, at the time when the plans for the Federal Reserve Act had 
not yet been framed. 

124 



BANK-NOTES AND LENDING POWER 125 

presented. If so, and if made intelligible to the general 
public, there was a good chance that they could be im- 
pressed upon Congress and enacted into law. 

Of course we have to beware of the man with a cut- 
and-dried system, who has a beautiful theory sure to 
prevent all panics and to cure all the ills of industry. 
As in the case of any disease, we must first find out 
accurately what is wrong, and next try to discover a 
remedy to meet the particular ill. First, then, as to 
the difficulties disclosed in the past which must be 
overcome by a correction of our monetary system. At 
that time (1910) Secretary MacVeagh by his urgent sug- 
gestions to the national banks to organize currency asso- 
ciations under the Aldrich-Vreeland Act of March 30, 
1908, in order to be prepared for an expansion of bank- 
notes in case of an unexpected emergency, consciously 
or unconsciously indicated his belief that monetary and 
credit emergencies could be met by the issue of bank- 
notes. On the other hand, if his words were correctly 
reported, the chairman of the National Monetary Com- 
mission expressed the belief that the problem was not so 
much one of circulation as it was one of the organization 
of credit. The problem seems to shift between bank- 
notes on the one hand, and the power of a bank to lend 
on the other; (1) the needs of the public for currency 
and (2) the needs of a bank when under pressure in meet- 
ing demands for loans. 

§ 2. The needs of the public for currency to act as a 
medium of exchange in buying and selling goods, in pay- 
ing wage-rolls, in travel, etc., are obvious. In certain 
sorts of transactions, mainly in retail trade and in dis- 
tricts unused to banking methods, some form of money 
must be passed from buyer to seller. In total amounts, 



126 BANKING PROGRESS 

however, these transactions are insignificant in com- 
parison with those on a large scale which are carried on 
by checks, drafts, or bills of exchange — without the use 
of any forms of ordinary money. With an increasing 
population, but chiefly with the increasing products 
bought and sold at retail, the demand for currency, such 
as it is, must increase absolutely in greater or less sums. 
For such needs an elastic bank-note circulation, slowly 
rising but expanding and contracting sharply with sea- 
sonal demands, is imperative. Our old national bank 
circulation did not provide for this elasticity. It ex- 
panded and contracted without any direct relation to 
the demands of the community. To this point of elas- 
ticity much emphasis has been directed, and its im- 
portance should not be minimized; but it is to be 
doubted if it is as vital as some suppose. If we used 
only bank-notes (or other paper money) as a medium of 
exchange the insistence upon an elastic bank-note cir- 
culation would be of first importance; and even in the 
limited field in which actual money is imperative, the 
need of an elastic bank-note issue to the general public 
remains highly important. But since we have as a me- 
dium of exchange a deposit-currency which is perfectly 
elastic, elasticity of note-issues should receive attention 
only in the proportion of the importance of bank-notes 
to other media of exchange, under normal conditions of 
business. 

Still keeping in mind, however, the needs of the public 
for a medium of exchange and not the needs of the bank 
itself, it may possibly appear to many that the demand 
of the public for expanding issues of currency is of vital 
importance in a time of financial distress, such as was 
that in the autumn of 1907. To those who set most 
store by the virtues of an elastic bank-note issue this 



BANK-NOTES AND LENDING POWER 127 

seems the crux of the whole matter. It is supposed that 
in a time of stringency the public will demand more cir- 
culation; and to support this view the events of the panic 
of 1907 have been drawn upon as proof. It is true, of 
course, that greenbacks, silver certificates, or bank-notes 
could not be had in most cities during the height of the 
panic in 1907, even in small sums; and as a consequence 
the clearing-house associations issued clearing-house notes 
(as distinct from clearing-house loan certificates) for cir- 
culation among the public. Without doubt, this inability 
to get cash for a small check on a bank or at a paying 
office made a deeper impression on the minds of the peo- 
ple than any other event during the panic. It was the 
belief in the need of more money, based on this experience, 
to which Congress evidently catered when it passed the 
Aldrich-Vreeland Act, as a provisional measure before 
a coming election in 1908. It was, as every one must 
admit, a striking commentary on the inadequacy of our 
banking and monetary system that it was impossible for 
the banks to supply to employers of labor and for the 
small needs of every day a relatively small amount of 
currency having a general circulation. Yet, on the other 
hand, it is a fact that the total amounts of the clearing- 
house notes issued for the use of the public were not 
large, nor were they long outstanding. Moreover, as 
affecting the ability of the producing and trading houses 
to weather the stress of the panic, they had practically 
no influence whatever. The banks were more fright- 
ened than the public. The demands of the small local 
banks for additional precautionary reserves drew down 
the cash reserves of city banks more than did the de- 
mands of business men. This was the reason for the 
scarcity of circulation. The holding on to their cash by 
city banks was primarily in the interest of reserves, and 



128 BANKING PROGRESS 

therefore in the interest of those who might possibly wish 
loans or who had to be carried for a time. 

The power to expand their note-issues (which are lia- 
bilities) could not have added directly to the cash re- 
serves of the banks and thus have enlarged their power 
to aid needy borrowers. It is true, however, that an 
expansion of note-issues would have aided the banks in- 
directly; it would have allowed them to satisfy the urgent 
demand of the public for a medium of exchange by pass- 
ing out their notes and thus would have enabled them to 
retain lawful money which could be used as reserves to 
support their loans and deposits. But, primarily, the 
issue of bank-notes is for circulation in the hands of the 
public and not for any serious advantage which they 
render in increasing the power of the bank to lend and 
to stave off a panic. Accordingly, the prevailing idea 
that we must provide against future panics and avoid a 
repetition of what happened in the panic of 1907 by ar- 
ranging for the rapid issue of bank-notes in a time of 
emergency is quite aside from the real point; for it is 
based on the wrong assumption that it is the lack of cur- 
rency in the hands of the public, and not the difficulty 
of the banks in lending, which is the critical thing at 
such a time. 

This popular insistence on the view that we can pre- 
vent the occurrence of panics and meet all the dangers 
of a financial panic once it is upon us by the device of 
an expansion of bank-notes is, in my judgment, based 
on an erroneous analysis of banking operations in times 
of pressure. Very respectable authorities have asserted 
that our monetary system is radically at fault so long as 
it will not prevent the occurrence of panics. And the 
belief that the Bank of England or the Bank of France 
— as central institutions — have been able to head off 



BANK-NOTES AND LENDING POWER 129 

speculation and avert the evils of expanded credit have 
been referred to as instances of what could be done by a 
central institution in this country. We have been led 
to think that the issue of notes was the means by which 
the dangers of the crisis were met and its inconveniences 
reduced; in the case of England by the suspension of the 
Bank Act bringing out more notes from the issue de- 
partment; and in the case of France directly by the in- 
crease of notes of the Bank of France. As we shall see 
later this appeal to the banks of England and France is 
wholly unfounded in fact. 

The reserve city bank which can quickly increase its 
own notes can supply the demands made upon it by 
country national banks and correspondents — provided 
the country bank wishes currency only for circulation in 
its neighborhood and not for its own reserves. Here, 
again, the new bank-issues do not give the pivotal aid 
which some suppose always comes from additional cir- 
culation. Not being lawful money, they could not be 
used in reserves and therefore would not — and could not 
— improve the lending power of the local country bank. 
They would, however, as we have seen, supply currency 
to the country bank which could be paid out, if urgently 
demanded, and thus indirectly protect reserves. 

Another advantage in emergency bank-notes, of course, 
is the use that can be made of them by national banks 
having relations with State banks and trust companies. 
By issuing their own notes they may exchange them for 
lawful money held by banks outside the national system. 
In this way they can indirectly increase their lawful 
money and consequently their power to lend. 

All the above advantages are patent and are argu- 
ments in favor of a margin of elastic note-issues. But 
such issues have only a limited importance and would 



130 BANKING PROGRESS 

not cure the fundamental difficulties existing in times of 
panic. The principal reason for this statement exists in 
the fact that, obviously, the bank cannot replenish its 
reserves — which are an asset — by an addition to its own 
notes, which are a liability. Apart from its illegality it 
is a banking lie. 

Moreover, the use of its cash resources in the direct 
purchase of any kind of bonds or securities to be de- 
posited for the protection of its emergency notes would 
not only not improve but really reduce the power of a 
bank to lend and thus reduce its ability to aid needy 
borrowers. A sum of $100,000 in lawful money in the 
reserves would support loans and consequent checking 
accounts of from $400,000 to $600,000 when borrowers 
are calling for help — provided borrowers used checks as 
a means of payment. Therefore, a bank would cripple 
itself should it invest $100,000 of lawful money in securi- 
ties in order to issue only $100,000 of note-issues — thus 
allowing loans of only the same amount — provided bor- 
rowers used notes as a means of payment. Consequently, 
no system of note-issues based on the purchase of securi- 
ties by lawful money would touch the centre of the 
need. 

Finally, too much is made of the need of an elastic 
bank circulation in a time of panic in view of the fact 
that we already have a perfectly elastic medium of ex- 
change in our deposit-currency, especially for all large 
transactions. The term "money" is loosely used. We 
use gold as a standard, but we do not use it to any appre- 
ciable extent as a medium of exchange. More than 95 
per cent of our large transactions are performed by a 
check and deposit currency which rises and falls exactly 
in proportion to the exchanges of goods which call forth 
loans and bank-deposits. Under existing familiar methods 



BANK-NOTES AND LENDING POWER 131 

of payment by checks and drafts, the borrower who is 
able to get a loan in a time of stress has no difficulty 
whatever in meeting his maturing obligation by a check 
on a solvent bank. To get the loan is the important 
thing — not the particular form of liability which the 
bank gives him on making the discount. In fact, on 
getting the loan the borrowing merchant would not wish 
to take out notes and then be obliged to find a place in 
which to deposit them again. It is clear, therefore, that 
the mere power to issue bank-notes in itself is not the 
only nor the most important way of meeting an emer- 
gency brought on by a disturbance of credit. 

It is a crude thought that an increase of bank-notes is 
needed by the general public as a medium of exchange on 
the theory that business men are unable to exchange goods 
because of a scarcity of currency. The real difficulty in 
a time of stress resides not with the general public and 
the media of exchange — for checks are as good as ever as 
a medium of exchange if there are deposit-accounts on 
which they can be drawn — but with the banks, with the 
power of the banks to expand their loans. This is the 
pivotal thing in any plan to relieve the distress of a 
financial panic (in spite of those who are urging an elastic 
currency as a cure-all). 

§ S. So much for the relation of bank-issues to the 
situation created by a financial crisis; but as has been 
already pointed out there are other elements in the situa- 
tion of far greater importance. When we look back to 
the panic of 1907 we find three important happenings, 
connected in purpose and need, which altogether tran- 
scend the minor question of the issue of bank-notes, or 
of clearing-house-currency for public use. These three 
points of central importance have to do with the lend- 



132 BANKING PROGRESS 

ing power of the banks and are as follows: (1) The im- 
portation of gold; (2) the deposit of lawful money with 
the banks by the Treasury; (3) the issue of clearing- 
house loan certificates. 

Every banker, every borrower, who was concerned 
with the work of preventing disaster from spreading in 
1907 knows how dominating were these three matters. 
Why ? Because they directly touched the power of the 
banks to lend. There was a crisis, not because of a scar- 
city of a medium of exchange in the hands of the public, 
but because the city banks had had excessive demands 
made upon them for loans and because they held some 
paper which had become more or less unsound. A crisis 
comes because credit has been unduly expanded in a 
period of prolonged prosperity; because in an optimistic 
spirit men have entered into transactions beyond their 
actual means, as is shown when the test of actual pay- 
ment is exacted; and in a time of fright collateral as well 
as goods fall in price. In such a situation liquidation 
needs time if disaster is to be prevented. The banks 
are even called upon to carry houses who have been doing 
a legitimate business but who are now in trouble. Just 
when timid persons or country banks are drawing down 
cash reserves, the banks are forced by the situation to 
increase their loans. In the one week ending November 
2, 1907, the reserves of the New York banks fell $37,000,- 
000, while loans were increased $60,000,000. Such action 
showed that the New York banks met a difficult situa- 
tion with courage and good judgment. At their own risk 
they came to the rescue of a hard-pressed business public. 
Everything centred in those things which would aid the 
lending power of the banks. It is needless to say that 
the issue by the bank of its own liabilities in the form 
of notes would have been an insignificant palliative and 



BANK-NOTES AND LENDING POWER 133 

would not have touched (except as before mentioned) the 
cash reserves and the power to lend. The one central 
thing to be done at the moment was to increase reserves. 
Here is the crux of the whole matter, whether it is a 
time of an impending stringency or the storm-centre of 
a crushing panic. The bank's own notes (its own lia- 
bility) cannot legally or morally be used to fill up its 
reserves (the bank's active asset). Here is the fatal de- 
ficiency of bank-note issues as a means of curing a panic. 
The one thing needed was lawful money which could be 
used as reserves. We must face facts and not be led 
away by theories. The New York banks got this lawful 
money in two ways: (1) by importing gold and (2) by 
deposits from the Treasury. 

They imported gold as a means of enabling them to 
aid needy borrowers. They used their resources to buy 
or borrow over $100,000,000 of gold because it was one 
of the forms of lawful money by which reserves could be 
filled up. By any one who had the means of purchase, 
gold could be got in a week from Europe. Therefore, 
gold proved to be the one part of our monetary system 
— besides checks on deposits — which was perfectly elastic. 
It could be increased by importation or decreased by ex- 
portation at will. 

Gold, however, was not the only form of lawful money. 
When banks were being drained of their reserves, the main 
recourse was to the Treasury of the United States. (2) 
Unlike bank-notes, government deposits of lawful money 
directly increased the reserves and increased the lending 
power of the banks from four to six times the deposits. 
The secretary, in leaving the largest sums in banks in 
New York, the centre of the disturbance, gave his aid 
where it would do the most good. It is obvious that the 
service rendered by the importation of gold and the 



134 BANKING PROGRESS 

deposits of lawful money by the Treasury could not have 
been accomplished by issues of bank-notes. 

The most important of the devices resorted to in 1907, 
however, as well as in former panics as far back as 1861, 
was the issue of clearing-house loan certificates. (3) What 
was the point of their issue? It was not that the coun- 
try needed more money for general circulation or more 
media of exchange, but tliat the banks whose reserves 
had declined needed aid for the purpose of lending to 
hard-pressed borrowers. In a crisis what is wanted — 
and wanted above all other things — is the loan. Once 
given the loan, the borrower has no difficulty in finding 
a medium of exchange, by which he can transfer his 
credit in a way to meet his maturing obligation. The 
loan is the primary thing. All that the creditor demands 
is a means of payment acceptable in his community. It 
is just at this point that I venture to say we find the most 
confusion of thinking and the greatest amount of loose 
talking. It is carelessly assumed that the great need 
is an issue of bank-notes, when in reality the great need 
is some means — whatever it may be — which will enable 
a bank to make loans to a client, who can thereby be 
saved from failure and from hasty and ruinous liquida- 
tion. The whole object of clearing-house loan certificates, 
then, is — not to provide currency — but to make loans 
possible to legitimate though needy borrowers. After 
loans are made, checks provide all the means of payment 
any one needs. The increase of a bank's liabilities does 
not increase its reserves or its power to lend; so that the 
issue of bank-notes — except as above indicated — is wholly 
aside from the point. 

§ 4. One result of the publications of the National 
Monetary Commission is that we ought to know much 



BANK-NOTES AND LENDING POWER 135 

more than before about the experience of the great banks 
in Europe. 1 But deductions from Europe, as has been 
pointed out by the chairman of the commission, must 
be made with caution. In England conditions as to 
payments by deposit-currency are much like our own; 
but in France very little work is done by checks drawn 
on deposits and nearly all by the notes of the Bank of 
France; and much the same is true of Germany. Thus 
while the general principles of banking would work out 
similarly in England, France, Germany, and the United 
States, the instruments through which they operate 
would be very different. 

In England, in a crisis, aid seems on the face of things 
to have been rendered by an increase of the Bank of 
England notes, when the Bank Act of 1844 was sus- 
pended. In fact, as every one knows, the act previous 
to 1914 had not been suspended since 1866; and even 
when suspended, very little use of the new notes was 
made. Why? Although under the same management, 
the issue department is as much separated from the 
banking department as if they were different institutions. 
The gold and securities behind the notes in the issue 
department are entirely separated from the resources of 
the banking department. Therefore, the latter can use 
the notes of the issue department in its reserves. The 
whole point of the suspension of the Bank Act lies, then, 
in the fact that the banking department can fill up its 
reserves by taking securities to the issue department and 
getting notes for them under a temporary suspension of 
the law. The immediate object is to increase banking 

1 In all there are no less than ten volumes on European banks issued by the 
National Monetary Commission, amounting to 4,096 octavo pages (of which 
that on the German Bank Inquiry of 1908 alone contains 1,162 pages), to say 
nothing of other subjects treated. For students these works are highly useful 
and convenient. 



136 BANKING PROGRESS 

reserves so that loans can be made freely; while the idea 
of getting out more notes into general circulation, on any 
theory that the public needs more money, is not at all 
considered. The mere possibility of a resort to suspen- 
sion is sufficient to quiet alarm because legitimate bor- 
rowers know they can get loans whenever required, and 
therefore practically little or no use is ever made of the 
new notes. Of late years the change in the rate of dis- 
count has been sufficient to prevent reserves from falling 
to a point where suspension was ever necessary. Here 
again in an emergency it is a question of the lending 
power of the bank and not the need by the public for 
more bank-notes as a medium of exchange. 

In France things are otherwise. An increase of loans 
by the Bank of France is necessarily carried through by 
an issue of more notes. Within the outside limit set by 
law the bank can increase its issues at will. The essen- 
tial thing, of course, is the ability to get a loan in an 
emergency; and when that is obtained, as a matter of 
course the bank supplies the special form of liability 
which the business public demands — which in France is 
not a deposit-account but a note-issue. Either would 
serve the same purpose as a means of payment; but that 
one is taken which custom prescribes — the check in Eng- 
land, the note in France. The fundamental thing is to 
be found in the power to lend and not in the note-issues. 
And back of that, it is the phenomenally high character 
of the short-time paper which allows the Bank of France 
quickly to adjust itself to changed conditions, together 
with the policy of keeping very high metallic reserves 
behind the notes — perhaps 85 per cent in normal times. 
They have escaped panics in France by greater care than 
is given here in selecting only high-class paper at the 
central bank. Copper speculation, however, can bring 



BANK-NOTES AND LENDING POWER 137 

disaster to a bank there as well as here. In general, the 
Bank of France has been able to maintain a low and uni- 
form rate of discount chiefly because it is not a money- 
making machine and is excessively conservative in the 
kind of paper it discounts. 

§ 5. Working directly from the facts of our own ex- 
perience and from a reading of the volumes of the National 
Monetary Commission, we may be permitted a very 
brief statement of the constructive measures which should 
be undertaken to prevent the excessive and ruinous re- 
sults of credit expansions in the future. 

First of all, emphasis must be placed on the indisputa- 
ble truth that no monetary legislation can prevent busi- 
ness optimism, overtrading, and the recurrent waves of 
speculation and liquidation. The control of such move- 
ments, which are sure to be pressed upon banks by an 
eager, money-making public, lies primarily in the hands 
of the banks. The banks are the servants of their con- 
stituencies; as a rule, they do not lead, but are apt to 
follow the demand of their customers; but they must 
not be willing to follow recklessly. Not infrequently we 
hear it said that European countries, with large central 
banks, have a system which prevents panics. The truth 
is that panics have been largely avoided in the last decades 
in such countries as England, France, and Germany be- 
cause the management has been cautious and conserva- 
tive in granting loans. Quite irrespective of the differ- 
ences between the forms of banking organization in the 
United States and the forms employed in England, 
France, and Germany, we could as effectively suppress 
potential panics as they if we were as willing as they to 
scrutinize loans. 

In the second place, we must in no way relax our efforts 



138 BANKING PROGRESS 

to satisfy the great need of an elastic bank circulation. 
We need what might be called marginal elasticity — a 
change of relatively small amounts on the margins of a 
fairly large normal circulation, dependent for its amount 
wholly on the demands of trade and not on the fiscal 
needs of the government. The various bills presented to 
Congress — chief among which was the bill of the American 
Bankers' Association 1 — bear on this general point. They 
were important; but as previously explained they did not 
provide a remedy for the situation existing in a time of 
panic. Expansion of credit can go on, and has gone on, 
through the banking department of the Bank of England 
without the issue of any notes and solely through the 
creation of deposit-accounts as the consequence of ex- 
panded loans. Therefore, we must admit the fact that 
an elastic bank-note circulation, while bringing needed 
reforms, will not accomplish in times of stress what most 
persons have in mind when urging a change in our 
monetary system. 

Having now disclosed the real need, how can that need 
be met effectively? In the main, assistance must come 
in such a way that reserves can be enlarged with safety. 
Therefore, the emergency issues — if any are allowed — 
must be in some form of lawful money. How and by 
whom are they to be issued? 

Certainly not by the government. The very first les- 
son of public finance is to learn to separate the fiscal from 
the monetary functions of the Treasury. The State must 
separate its income and expenditures, its borrowings and 
payments, its fiscal duties, wholly and radically from its 
control over the monetary standard and the media of 
exchange. To confuse or to mix these is to invite dis- 
aster at the first real crisis. Compare the chaos into 

1 See Appendix I. 



BANK-NOTES AND LENDING POWER 139 

which we fell when we confused these two things on and 
after February, 1862 (on making the first issue of green- 
backs as a loan), with the stability of the French standard 
during the enormous expansion of loans in their crisis 
of 1870-1873. 

In brief, what is the essence of the remedy ? Clearly 
enough, the lending power of a bank cannot be increased 
in an emergency by means of an increase in liabilities. 
It can come only by an operation dealing with its assets 
and in such a way that a part of the assets — either bank- 
able short-time paper or securities — can be transformed 
into means of payment which will enlarge the reserves. 
The whole emphasis should be put upon the matter of 
lending power. In the past this end has, in fact, been 
accomplished either by using securities to import gold, 
or to obtain government deposits, or by getting clearing- 
house certificates to the amount of 75 per cent of the 
value of chosen commercial assets. Such methods are 
irregular, voluntary, and clumsy. The underlying prin- 
ciples, however, should be incorporated into practicable, 
simple, legal means open to all, and well understood be- 
fore any emergency arises. 

The issue of clearing-house loan certificates has been, 
in my judgment, a means of averting untold disaster in 
many crises; the collateral behind them has been based 
on the fundamental business of the country, and they 
have always been retired at an early date without the loss 
of a dollar. Yet it is clear that as a practical device 
they are somewhat clumsy and possibly exposed to the 
10 per cent tax on State-bank issues. They may be, 
however, only the first step in an evolution to something 
even more effective but built up on the same lines. It is 
always wise to allow the remedy to grow out of our past 
experience rather than to introduce an entirely new 



140 BANKING PROGRESS 

scheme to which it may take a long time to get ad- 
justed. 

Therefore, the central point of our banking reform,, 
so far as I am able to suggest anything practical, is an 
organization of national banks, supervised by the gov- 
ernment but not under government management, which 
shall have the power, under regulations securing great 
care in the selection of collateral, to transform picked 
assets and securities into a means of payment which can 
be used to increase reserves. If notes are also issued 
there should be proper elasticity. Such a method, after 
all, is essentially the same as that used in a crisis at the 
Bank of England — the country whose conditions are 
most nearly like our own. If we accept these principles 
and the general purpose, it would not be difficult to draft 
the law which should contain them. 

We ought not to be wedded to names or preconceptions. 
It is immaterial whether such an organization is called a 
central bank or not. It is material, however, that it 
should accomplish the purpose of enabling any individual 
bank to meet a temporary paroxysm of credit by getting 
more reserves and by increasing its lending power through 
the deposit of first-class collateral. My instinct is against 
any one large, centralized institution the management 
of which might become an object of attack or a political 
prize in a campaign. So far as I can now see, it ought 
to be built up out of the present clearing-house organiza- 
tions. There should be common action and conference 
of those who know the conditions of business in all parts 
of the country; but the actual judgment, when the qual- 
ity of the paper and securities offered by a bank in order 
to obtain those means of payment is to be passed upon, 
should obviously be given only by those in certain parts 
of the country who are familiar with persons and trade 



BANK-NOTES AND LENDING POWER 141 

\ 
in the localities where the requests are made. More- 
over, the relation of State banks and trust companies 
to the national banks in the large cities in a time of crisis 
can be best regulated through organizations like the 
clearing-house boards. There should be no difficulty 
whatever in creating local or district clearing-house 
boards, 1 chosen by the banks themselves — just as clear- 
ing-house committees are now chosen — who should pass 
upon the issues of those Reserve notes. These district 
boards might then be united or represented for common 
action in a central board, 2 who might have a veto upon 
the extreme action or the possible unwisdom of any one 
local board. The scheme has, moreover, the political 
advantage that it does not propose a money-making in- 
stitution nor a financial "octopus," but a simple, direct 
method of enabling the borrowing public to get aid from 
banks in time of distress. 

Were such an organization once put into operation I 
am firmly convinced that we should henceforth be pre- 
served from the highly terrifying and unnecessary parox- 
ysms of credit which have characterized our past financial 
history. More than that, we should then come to under- 
stand by actual experience — just as in England since 
1844 — that our expansions of credit and its liquidation 
may come and go independently of the quantity of bank- 
notes outstanding. Attention will then be taken away 
from the minor question of the quantity of notes in the 
hands of the public to the vital question of the character 
of the credit granted and to the control and vigilance 
over the kinds of discounts made by a bank. From what- 
ever angle we approach the banking business we are 

1 This suggestion, put out in 1910, was the essence of what became Federal 
Reserve Banks in the twelve districts. 

2 Later the Federal Reserve Board carried out this function. 



142 BANKING PROGRESS 

always forced, sooner or later, to recognize that every- 
thing depends upon the quality of the discounts and the 
kind of assets held as a consequence of making loans. 
The measures recently put into force by the comptroller 
of the currency, such as more stringent examinations, 
are to be highly praised because they bear directly upon 
this general principle. It lies at the centre of all real 
:j durance or protection to depositors; and it lies at the 
centre of our whole question of banking reform which 
aims to relieve us of the disasters of sudden and forced 
liquidation in a time of panic. 



CHAPTER VIII 
POLITICAL HISTORY OF THE FEDERAL RESERVE ACT 

§ 1. The Aldrich-Vreeland Act of 1908, 1 passed largely 
for political effect and expiring June 30, 1914 (later ex- 
tended to June 30, 1915), was the cover under which 
preparations were made for a thorough revision of our 
currency system. That act was negative in its working, 
and before the European War no resort was ever made 
to its provisions for issuing emergency notes through cur- 
rency associations. In the autumn of 1912 and 1913 
the tension of credit was probably as extreme as in 1907, 
but, as was to have been expected, no use was made of 
the act. 2 The essential theory of it was the obvious 
dependence on an issue of bank-notes as the remedy 
for a stringency; while, in truth, the difficulty lay in 
the shortcomings of our credit organization. Deeper 
than the inelasticity of the bank-issues lay the inelas- 
ticity of credit and of the power to lend. It is interest- 
ing, therefore, to watch the development of reform pro- 
posals and to see how far they showed an understanding 
of the real weaknesses of our banking and monetary 
system. 

The formation of currency associations under the act 
of 1908 had been urged by Secretary MacVeagh 3 on the 
various clearing-house centres; but although formed 

1 For a full study of this law, see Chapter IV. 

8 A considerable issue of Aldrich-Vreeland notes was made in the crisis of 
1914, after the act had been amended by the Federal Reserve Act of 1913, 
and also by legislation in August, 1914. Cf. Laughlin, Credit of the Nations, 
pp. 299-305. 

3 In 1910. See Fin. Report, 1910, p. 5. 

143 



144 BANKING PROGRESS 

they were organized with much scepticism as to their 
actual use. The tax on the notes was unintelligently 
heavy, making their use almost prohibitory. On the 
other hand, if resort had been made to these notes rather 
than to clearing-house certificates, they would have had 
the advantage of a circulation wider than the narrow 
field of the certificates. Since they could not, however, 
be used as lawful reserves by national banks, they would 
not, in fact, have touched the lending power of these 
banks as directly as did clearing-house certificates. If 
A could not get a loan or extension at Bank X, and trans- 
ferred his account to Bank Y on the promise of notes to 
be obtained through a currency association, A might 
have used these notes to take up his obligation held by 
Bank X; the next day Bank X could have presented 
these notes to Bank Y as a demand obligation against 
cash reserves; thus they would not have been so useful 
as clearing-house certificates which could have been used 
in settling balances between banks. Yet, apart from the 
tax, some bankers believed that these notes would have 
been effective in time of stress. Certainly, by being paid 
out to the public, they might have prevented, to some 
extent, the drawing-down of banking reserves of lawful 
money. At the best they could have been only a pallia- 
tive. Yet it should be noted that these notes, whatever 
their efficiency, broke with the past unmistakably by 
being obtainable on the pledge of other security than 
United States bonds. 

The provision in the act creating a National Monetary 
Commission had important consequences. Its composi- 
tion, however, was typical of our methods: the eighteen 
members were chosen equally from the two Houses of 
Congress, and practically none of them were experts. 1 

1 It was at first proposed to have six members outside of Congress. Cf. p. 61. 



POLITICAL HISTORY OF ACT 145 

Consequently, the education of the commission itself 
was the first duty, and a considerable number of treatises 
were prepared at the behest of the commission on topics 
more or less pertinent to the subject. The formation of 
a concrete plan of reform, however, came through the 
visits of the chairman and others to Europe and through 
some other influences at home. It is to the credit of the 
chairman, Senator Aldrich, that, in comparison with his 
attitude in 1908, 1 he performed a complete volte face. 
European experience, well known already to American 
students of this subject, was now driven home on those 
who might influence the action of Congress. But the 
definite outlines of the plan of the commission presented 
January 17, 1911, must have been due to the suggestions 
of a few experienced persons in this country, who were 
consulted by the chairman near the end of 1910. 2 What- 
ever its origin, the plan actually laid before the country 
by the commission had the distinction of attacking the 
pivotal weakness of our system — the organization of 
credit. That was an epoch-making advance. Into the 
personal and political animosities connected with the chair- 
man of the commission it is needless to enter here; but in 
getting legislation it is obvious that political prejudices 
are facts as much as stone walls, and they had their due 
influence on the result. 

§ 2. In fact, political considerations were ruling in 
regard to a subject which of all others ought to have had 
non-partisan treatment. During the campaign of 1912 
every effort was made to keep the currency question out 
of politics. The fact, however, that the plan of the com- 

1 Cf. supra, pp. 54, 68. 

2 Besides Mr. Aldrich those most concerned in its making were, by common 
report, Messrs. Paul Warburg, F. A. Vanderlip, A. Piatt Andrew, and others. 



146 BANKING PROGRESS 

mission was intimately associated with the name of Sen- 
ator Aldrich, the head of the Protectionist Republicans, 
was present in every one's mind. This fact forced the 
question into politics. The commission, from the Re- 
publican point of view, made the fatal mistake of delay- 
ing the presentation of its report for four years until the 
Lower House became Democratic. The reaction in favor 
of the Democratic party made it patent that no bill un- 
satisfactory to the Democrats could become a law. But 
the demand for non-partisan action was still so great that 
even Democratic leaders believed that, while the matter 
could not be brought up in the winter session of 1911- 
1912, just before a presidential campaign, it ought to be 
taken up in the short winter session of 1912-1913 after the 
election. Political events, however, swept these hopes 
aside. 

The Democratic convention at Baltimore saw a strug- 
gle between the conservative and radical elements of 
the party in which, in a sense, the latter won. Although 
Mr. Bryan could not control the result, neither could the 
conservatives. The nomination of Woodrow Wilson, 
who was not Mr. Bryan's candidate, created a situation 
that made it seem necessary to placate Mr. Bryan by 
allowing him to write the platform; and the currency 
plank arrayed the party against "the so-called Aldrich 
bill or the establishment of a central bank." 1 The 
danger of making the subject a party issue was diminished, 
however, by the Republican platform, which declared 
only in favor of general principles and not for any specific 
plan. Consequently, the currency issue was little heard 
of during the campaign of 1912. The eccentric declara- 

1 It has been claimed that the true draft was altered by the omission of the 
letter "f," and should have read "Aldrich bill for the establishment of a cen- 
tral bank." 



POLITICAL HISTORY OF ACT 147 

tion of the Progressive platform drew no discussion. 
Very early in the campaign it became evident that Mr. 
Wilson would be elected. The election of a Democratic 
Senate later gave his party full control of legislation. 
Hence, Democratic leaders had no disposition to allow a 
currency act to pass in the short winter session, when 
they could very soon stamp their own impress on the 
most important problem up for solution since the Civil 
War — least of all a measure regarded as the handiwork 
of Senator Aldrich, a Republican leader. 

While Mr. Wilson spoke of giving the question non- 
partisan treatment, he had elements in his party difficult 
to be unified on common ground. 1 As early as September, 
1912, it was known that the Pujo subcommittee of the 
House, dominated by its counsel, Mr. Samuel Unter- 
myer, intended to report specific monetary legislation in 
connection with the investigation of the "Money Trust." 
This policy infringed on the legislative work of the Glass 
subcommittee. The conflict finally ended in the triumph 
of Mr. Glass (who in the extra session of the new Con- 
gress, April, 1913, became chairman of the full Banking 
and Currency Committee). In the meantime, by the 
summer of 1912, the so-called Aldrich Plan (reported in 
January, 1911, to both House and Senate) seemed to 
have become politically dead. In November, 1912, the 
Glass subcommittee was spurred into activity by the work 

1 The radicals in the House, like R. L. Henry of Texas, wished extreme action 
in connection with the investigation of the "Money Trust," hoping to get 
useful campaign material. The resolution demanding this investigation was 
finally sent to the Banking and Currency Committee, where it was given to 
one-half of the committee presided over by Mr. Pujo, then the chairman of the 
whole committee; while the other half of the committee, to be presided over 
by Mr. Carter Glass, next in rank to Mr. Pujo, was intrusted with the definite 
task of preparing legislation on banking and currency. To Mr. Glass's sub- 
committee the plan of the Monetary Commission and other bills were also 
referred. 



148 BANKING PROGRESS 

of the Pujo subcommittee. Up to that time, tentative 
Democratic banking bills did not go far, even proposing 
to leave untouched the existing inelastic national bank- 
notes secured by bonds. In fact, having seen divisions 
in the party because of silver and other monetary issues 
in the past, Democratic leaders were loath to take the 
chance of arousing discussion on- these questions. Poli- 
ticians hoped to dodge serious legislation by postponing it. 
Meanwhile public opinion, developed in a systematic 
way, had become intelligent and insistent in favor of 
thorough and constructive legislation. Foreseeing that 
this could come only through the Democratic party, the 
South was made the objective of an active propaganda 
in favor of banking reform. 1 So vigorous and successful 
was this work that, later, a Democratic Congress found 
many of its constituencies demanding legislation of a 
sound, specific character. In the Sixty-second Congress, 
in the Democratic House, the radicals were outnumbered 
2 to 1; and in the Sixty -third Congress the ratio was 
probably about the same. A Democratic Congress, 
therefore, called in extra session as early as November, 
1912, by President-elect Wilson, had to face the problem 

1 The National Citizens' League for the Promotion of a Sound Banking Sys- 
tem, with headquarters in Chicago, began a campaign of education through- 
out the country in June, 1910, giving main attention to the South, and to 
Progressive States in the West and Northwest. Effective organizations were 
established in forty-five States, chiefly among business men. Contributions 
were solicited from banks on the ground that they represented also the bor- 
rowing business public, who were mainly interested in the reform. A vast 
amount of material was printed in the newspapers and pamphlets, while a 
volume on Banking Reform (1912, 23 chapters, 8vo, pp. xii + 428) was pub- 
lished. For the man in the street simple exposition was supplied in a fort- 
nightly issue and in newspapers; but the volume on Banking Reform was a 
text-book for use by editors, speakers, and congressmen. Speaking was had 
especially in the South. The purpose of this organized and systematic work 
was to create public opinion in the home districts, and it had the expected 
result in the final votes in Congress. The League stopped its work November 
1, 1913. 



POLITICAL HISTORY OF ACT 149 

from which there was no escape. Then Mr. Wilson's 
firm, guiding hand appeared. He was evidently advised 
of the progress already made by the Glass subcommittee, 
but he kept his own counsel. From the very date of the 
calling of the extra session in November, the chances of 
currency reform seemed suddenly to become favorable. 
To Mr. Wilson's championship more than to any other 
force was the final legislative result due. It came to be 
expected that a banking and currency bill would, if pos- 
sible, be taken up in the extra session (spring of 1913); 
and the Glass subcommittee held hearings in January, 
intending to have a bill ready by the time the extra ses- 
sion convened. 1 

The still larger political significance of banking and 
monetary reform, however, cannot be disregarded. It is 
well known that the Democratic party had in past years 
sympathized with the pleas for unsound paper money, 
and had been committed to the free coinage of silver. 
The Republican party, it is true, was on its side respon- 
sible for the silver act of 1890. Fortunately, during the 
control of the Democratic party by President Cleveland 
his party was, with remarkable generalship, manoeuvred 
into a position of soundness on the silver question. When 
Mr. Bryan gained control and enforced on his party his 

1 The Glass subcommittee was at work on the bill early in December, 1912; 
hearings were held in January, 1913; and the bill was practically outlined be- 
fore the inauguration, and approved by President Wilson. In the extra session 
of the spring of 1913, the new House Committee on Banking and Currency 
had been named, with Mr. Carter Glass as chairman of the whole, only a 
short time before the House bill was introduced, June 18, 1913. The committee 
began work on the bill July 7; it was reported to the Democratic caucus early 
in September, ratified, reported to the House September 9, and passed by 
the House September 18. In the Senate, hearings were held on the bill until 
October 25; it was considered by the Banking Committee, of which Mr. Owen 
was the chairman, for a month; reported to the Senate December 1; debated 
until December 19; went to a conference committee, whence it was returned De- 
cember 22; was passed and received the President's signature December 23, 1913. 



150 BANKING PROGRESS 

views in favor of the free coinage of silver, and the issue 
of all paper money by the government (involving the sub- 
stitution of government paper money for national bank 
notes), the Democratic party was successively beaten in 
every campaign which pivoted on those issues. It was 
not the strength of the Republican party, but the aberra- 
tions of the Democratic party on banking and currency, 
which drove a majority of the voters to elect Republican 
presidents. In view of the disasters which had come 
upon Democrats through monetary issues, it is easy to 
understand the reluctance of their leaders to take them 
up just when party success in the national elections seemed 
possible. Nevertheless, the development of industry in 
the South, and the spread of a business, rather than a 
political, point of view on currency questions throughout 
Democratic States brought a growing belief that only 
by passing a great constructive act on banking and cur- 
rency could the Democratic party wipe out the distrust 
due to past eccentricities on those issues, and win that 
confidence from the business element which was essential 
to remaining in political power. The statesmanship by 
which President Wilson, with the aid of Democratic lead- 
ers, put their party behind an epoch-making, construc- 
tive measure and passed it on December 23, 1913, is a 
monumental event in our political history. It assumes 
the character of a political miracle. No little credit for 
the political result also should be assigned to Mr. Bryan, 
who brought his large following to the support of the 
measure. Hereafter, the political lines on money and 
banking questions must be drawn in entirely new ways; 
so that the effects of this act on both our business and 
our political development can scarcely be exaggerated. 

§ 3. The preliminary draft of the Federal Reserve 
Act was formed by the subcommittee of the House Bank- 



POLITICAL HISTORY OF ACT 151 

ing and Currency Committee, under the chairmanship 
of Mr. Carter Glass, in the winter of 1912-1913. The ex- 
pert of this committee and afterward secretary of the 
Federal Reserve Board, H. Parker Willis, had probably 
more influence than any other man in shaping the measure 
in its formative legislative period. Inasmuch as the in- 
cubation of banking reform had been going on through 
the struggles of many years, the final result could not be 
traced to any one source or to any one man; but the 
main principles in it were already the common property 
of trained men in Europe and the United States. The 
real problem of statesmanship was in creating a bill 
which would meet the varying points of view of those in 
power and yet be sound; and the final act shows in many 
sections, as was inevitable, the evidences of struggle and 
compromise. 

Mr. Willis, who was intimately acquainted with the 
events going on in the winter of 1912-1913, and in the 
months of active legislation during the following extra 
session, says of the origin of the bill: 1 

It is not drawn, even largely, from any single source, but is 
the product of comparison, selection, and refinement upon the 
various materials, ideas, and data rendered available through- 
out a long course of study and agitation. Many bills embody- 
ing the same general line of thought that now finds expression 
in the new act have been offered in Congress; some have been 
suggested outside that body. The most fundamental concept 
of all — that of uniting the banks of the country into organized 
groups — is found in the clearing-house organizations, 2 which 
in time of stress have pooled their resources and converted 
bank assets into the equivalent of reserve money. . . . [The 
earliest of the bills found useful] was the bill recommended by 
the Indianapolis Monetary Commission, which did not provide 
for co-operative unions of banks, but upon which the framers 
of the present act have evidently drawn for some of their ideas. 

1 American Economic Review, March, 1914, pp. 13 ff. 2 Cf. supra, p. 149. 



152 BANKING PROGRESS 

As to the indebtedness of the new act to the bill of the 
National Monetary Commission, Mr. Willis speaks as 
follows: 

By many the new law is regarded as a partial copy of, or 
plagiarism from, the Aldrich Bill; and that view has been 
widely expressed both in and out of Congress. That such was 
not the opinion of Mr. Aldrich himself, his scathing and bitter 
denunciation of the House bill seems to bear abundant witness. 1 
. . . The Aldrich Bill may be considered from two standpoints : 
(1) that of its theory and broad general plan on the one hand, 
and (2) that of its machinery and technic of construction on 
the other. From the first standpoint there is no shadow of 
relationship or similarity between the Federal Reserve Act 
and the Aldrich Bill. . . . The Aldrich Bill provided for a 
single central "reserve association" 2 with scanty public over- 
sight. . . . The new act . . . leaves banking as such to be 
practised by bankers; it vests the control of banking in the 
hands of government officers. The theory and purpose of the 
new act are widely different from those of the Aldrich Bill. . . . 

From the standpoint of technic ... the case is quite differ- 
ent. With regard to stock-issues, kinds of paper eligible for 
rediscounts, and not a few other particulars, the Federal Reserve 
Act follows lines laid down in the measure which bore the name 
of Senator Aldrich. In fact, the original House bill, for stra- 
tegic purposes, retained wherever it could safely do so, the 
language of the Aldrich Bill as regards banking technic, its 
framers recognizing that by so doing they enormously reduced 
the hold of the opposition. . . . Moreover, the most desirable 
features of the Aldrich Bill were found in its sections dealing 
with banking technic — upon which some of the country's best 
banking ability had been expended. . . . 

A review of the detailed provisions of the measure shows, 
therefore, that, while the conception of banking reform upon 
which it is founded is the same that has constituted the staple 

1 Proceedings of American Academy of Political and Social Science, October, 
1913. 

2 It was generally understood that the elaborate organization of the reserve 
associations and the system of control was the main personal contribution of 
Mr. Aldrich to the bill. 



POLITICAL HISTORY OF ACT 153 

of the banking reform movement of recent years . . . the act 
as a whole is based upon a conception and plan entirely its 
own, applies in many fundamental respects methods of con- 
trol and administration that have been given at least a new 
form, and includes several important innovations, not hereto- 
fore conspicuous in banking discussion, although admittedly 
significant, not to say necessary, to any thorough reorganiza- 
tion upon sound principles. 

§ 4. In order to aid in bringing about early action 
by Congress the author drew up in January, 1913, a 
memorandum of the political situation, which was sent 
to the President-elect. Whatever its effect, its contents 
may now Lave some historical value: 

The Glass subcommittee on currency and banking has un- 
doubtedly framed a bill which could be soon given out, even 
though no action could be expected at this (winter) session 
(1912-1913). Public opinion throughout the country is more 
developed in favor of action than is realized in Washington. 
It would be an error of political strategy to delay legislation 
beyond the spring (extra) session (1913), for the following 
reasons : 

1. To postpone it to the long session of 1913-1914 would bring 
congressmen face to face with a new election in the summer 
and autumn of 1914. If there is any hesitation now to treat 
the money question, it will be much stronger next year. That 
will probably mean another postponement. 

2. There have been certain psychological times when mon- 
etary legislation was possible: (1) After the agitation by busi- 
ness men in 1898 (following the silver campaigns) legislation 
was passed March 14, 1900; (2) after the panic of 1907, the 
public expected action again, but this great opportunity was 
frittered away by the Aldrich-Cannon group — rigging only a 
jury-mast in the Aldrich-Vreeland Act of May 30, 1908, which 
is practically an expression of incompetence; (3) again, at the 
present moment public opinion, especially among business men, 
is becoming impatient, restive, and urgent, after the constric- 
tion of credit last autumn which was nearly as severe as in 



154 BANKING PROGRESS 

1907. If legislation is not had at this juncture, it is likely to 
go over several years. 

3. It is now six years since the last panic; a boom in the 
next twelve months would prepare the material of overtrading 
which might issue in an unexpected breakdown of credit in 
the next two or three years. Delay until another panic has 
aroused public opinion would be ruinous political policy. 

4. The passage of tariff bills, on even one schedule, would 
certainly create more or less dissatisfaction with any adminis- 
tration; that is to be expected. To have the passage of a con- 
structive measure on currency and banking to its credit, along- 
side of the tariff revision, would be an important offset to tariff 
criticism, because it would especially appeal to the business 
men of the whole country. 

5. Whenever monetary legislation becomes imminent, in- 
evitably countless plans are proposed, some good, most cranky, 
and persons become partisans to this or that plan, so that agree- 
ment is impossible on any one measure. Before such crystalli- 
zation becomes possible, political sagacity demands the throw- 
ing of the party behind some bill (already thought out and ac- 
cepted by the few who really lead). It would be a rallying- 
point. Not one in 10,000 will be competent to judge of the 
bill on its merits; given its large, essential high-spots, popularly 
put, men will accept it on authority. 

6. The indication of the general features of the plan should 
come from Mr. Wilson to Congress and not from Congress to 
Mr. Wilson. He can speak for the people in demanding the 
socializing for the common good of a present strongly individ- 
ualistic banking system. 

7. The present is the critical moment. At the very time 
when the Glass subcommittee is nearly ready to report a bill, 
party leaders are obliged to consider the probable programme 
for the extra session. Those in the party who remember their 
disasters in past money campaigns are naturally disposed to 
urge delay. A dangerous situation may arise, if both sides 
begin to crystallize into antagonisms. It can be dissolved in 
a moment by six lines given to the public by Mr. Wilson, say- 
ing that banking and currency legislation should be taken up 
in the spring session. The desire for harmony in the party is 
so strong at Washington, and the will to help Mr. Wilson so 



POLITICAL HISTORY OF ACT 155 

evident, that such a declaration by him to the country would 
break up division before it could occur, and all would fall in 
behind the party measure. Moreover, it is conceivable that 
the authority of a President may be greater now than later 
when patronage troubles may arise. 

8. Finally, early publicity of the party bill is desirable. It 
will furnish a rally ing-point; discussion and publicity will be 
concentrated on this to the exclusion of all lesser bills and 
theories. Moreover, by drawing criticism, it will afford op- 
portunity for later perfecting the measure during its passage. 

9. In a tactful way, for which Mr. Wilson is eminently fitted, 
some common understanding on the bill should early be ar- 
rived at by the forces needed to give the measure support. 
The measure of Mr. Glass is likely to afford a reasonable com- 
promise with Mr. Bryan on government issues and asset- 
currency. Also, there is good ground for thinking that the 
National Citizens' League and the American Bankers' Associa- 
tion could be brought to support it, if its technical provisions 
are carefully worked out. Some informal conferences would 
settle all differences, which are now only matters of detail, and 
not of general principle. Thus an unmistakably active public 
opinion could immediately be created behind the party bill, 
if Mr. Wilson, from his coign of vantage, would give the word. 

It may be that this memorandum had no effect on the 
decision of the President; but, whatever the reasons 
were which actuated him, the bill was in fact introduced 
and passed in the extra session. Still, if it were never 
even seen by the President, it presents briefly the political 
situation at the time as seen by one closely connected 
with the campaign. 

§ 5. The actual result of the struggle has proved to 
be remarkably good; but the opportunity ought not to 
be let pass without comment on our American method 
of legislating on subjects requiring expert knowledge and 
experience. There is a certain assumption (with some 
rare exceptions) that election to the House or Senate of 



156 BANKING PROGRESS 

our national Congress makes the member an expert on 
all subjects that may come before him. In other words, 
even the members of committees are not experts; and 
yet these members usually insist on introducing their 
personal convictions into proposed bills. Members often 
publish to the world by their questions an abysmal igno- 
rance of the subject before them. Hearings are usually 
held, not primarily to have various sides of the problem 
presented by experts, but to enable the ignorant member 
to be taught and to understand some of the obvious parts 
of a proposed measure. In hardly any other country in 
the world would inexpert legislators attempt so to con- 
struct a bill. The matter would be first referred to a 
committee of impartial, trusted experts, whose report 
would then be thoroughly thrashed out by the legis- 
lators who are responsible to public opinion. Yet with 
us, the fact of election to Senate or House seems to create 
in the minds of those elected a suspicion of outside ad- 
vice. Since men who are primarily politicians, and have 
little or no expert knowledge or training, must be per- 
sonally convinced before a bill can even be reported from 
a committee, it is a perpetual wonder that workable laws 
on technical subjects are ever passed. What is the con- 
clusion? The actual process of legislation is not what 
on the surface it seems to be. The bill is not passed on 
its merits; for very few of those who vote on it know any- 
thing of its merits. This outcome, it may be said, is the 
necessary result of committee government. Not wholly; 
because that theory assumes that committees are experts, 
which they are not. The conclusion is that an important 
act gets on the statute-books, in our political system, 
only as a part of a given party policy. The man in com- 
mand of the party's fortunes, or the few leaders who 
work with him, agree on a measure and it is "put through " 



POLITICAL HISTORY OF ACT 157 

by the dominant party, even though these leaders know 
very little of the subject. The system as thus described 
is probably the reason why our laws on currency and 
banking have been so defective; and it may also explain 
why, by a happy conjunction of events, a remarkably 
good act has been passed, although few of those who 
passed it really understood the essential features of it. 

§ 6. The problem of banking and currency reform 
was complicated by a confusion of mind, even among 
bankers, in regard to the various kinds of banking which 
might be carried on by any one institution. We were 
in the midst of an evolution, not only in our business, 
but in our credit, organization. The banking organism, 
which had seemed fairly homogeneous, began to be re- 
solved (as if by some gigantic magnifying-glass) into parts 
having separate functions and purposes. Already the 
trust companies, organized under State laws, while re- 
taining their original departments, had developed depart- 
ments for commercial banking creating demand-liabilities. 
Meanwhile national banks, although essentially com- 
mercial institutions, began to establish savings depart- 
ments. Then, the growth of investment banking, and 
the promotion and distribution of securities to meet the 
phenomenal growth of savings by investors large and 
small, in a country of rapidly expanding wealth, assumed 
an overshadowing magnitude, and colored the whole 
character of American banking and finance. In addi- 
tion, the fact, well known to economists, began to be 
recognized by Americans generally, that we had no in- 
stitutions to cover the demands for agricultural credits 
in rural districts. The interrelations and analysis of 
these elements in our banking system are alluring and 
need a large treatment by themselves, but this must be 



158 BANKING PROGRESS 

reserved for another time and place; it is possible here 
only to refer to them in order to get a fairly clear under- 
standing of the new legislation of 1913. 
(Most of the national banks, as well as those under a 
State system, were carrying on two distinct kinds of 
banking under one management. The test of a com- 
mercial bank is that it creates demand-liabilities; con- 
sequently, it should hold only assets (chiefly the results 
of loans at short time based on actual transactions in 
goods) that are liquid and can be quickly or frequently 
converted into cash. The creation of demand-liabilities 
(chiefly in the form of demand-deposits) requires as a 
condition of sound banking a special kind of assets readily 
adapted to meet an instant demand for cash from cus- 
tomers. But the holding of investment securities by 
commercial banks has reached enormous figures; and 
any general demand for liquidation of long-time securi- 
ties in cash could not be met; because an offer on a large 
scale would result in a great fall in the stock-market, in 
the weakening of collateral held for loans, and an impair- 
ment of all credits, without creating the coveted cash. 
The desire to share in the profits of promotions led com- 
mercial banks to tie up resources in non-liquid form, with 
the expected results in time of panic. 1 

This confusion between commercial and investment 
banking, which was characteristic of the great cities, 

1 The holdings of securities other than United States bonds by all national 
banks, on January 13, 1914, were $1,020,494,711, of which $566,246,910, or 
more than one-half, were held by banks in the Eastern States (New York, New 
Jersey, Pennsylvania, Delaware, and Maryland); $45,255,914 by the Southern 
States; $215,119,106 by the Middle Western States; $34,792,121 by the Western 
States, and $65,155,202 by the Pacific States. It is to be noted, however, 
that the national banks on the same date show savings-deposits (presumably 
time-deposits) of $855,914,458, of which country banks held $755,914,458. 
For a further study of the legality and policy of security holdings of national 
\ banks, cf. J. H. Hollander, American Economic Review, December, 1913, and 
\ J. V. Hogan, Journal of Political Economy, November, 1913. 



POLITICAL HISTORY OF ACT 159 

found a counterpart in the small rural banks of the West 
and South. They too held investment securities; but 
they confused two distinct kinds of banking in a different 
way. National, as well as State, banks in rural com- 
munities created demand-liabilities; but because short- 
time commercial paper was often limited in supply, and 
because there were no institutions dealing with agricul- 
tural credits, the rural banks to a greater or less extent 
put their resources into paper based on land, or in non- 
liquid form. The confusion in regard to different kinds 
of banking in rural districts was thus matched by that in 
the great cities. The consequences were obvious: in 
the latter the essentials of reform were obscured by the 
hue and cry about "Wall Street control," which orig- 
inated really from the prevalence of promotions and loans 
on securities; while in the former, the desire to help the 
under dog (or small bank) led to provisions for rural loans 
on land wholly inconsistent with the refusal to accept 
loans on stock-exchange collateral. Such is the way of 
legislation in a democracy. 



CHAPTER IX 
A PROPOSED BILL 

§ 1. The author had been a member of the Indianap- 
olis Monetary Commission and drew up the report of 
1898; he had been called in to aid in preparing the bill 
of the American Bankers' Association in 1908; after the 
tentative draft of the Aldrich Bill was made, he, like 
many others, was asked for suggestions, but had nothing 
to do with its main formulation; and in 1911-1913, being 
charged with the conduct of a nation-wide campaign of 
education on banking reform, 1 he was also permitted to 
offer his own suggestions to the Glass subcommittee in 
the winter of 1912-1913. These suggestions were put 
into the form of a bill with a running commentary on 
various sections. Moreover, while fully understanding 
that no one draft was likely to be adopted in toto by the 
framers of the new legislation, he was led to present a 
complete bill containing in it some features, especially 
regarding the note-issues, which were too ideal to get 
into this law; but these provisions are here retained as 
part of the material out of which the general result was 
created. They may have some bearing on the banking 
development of the future. It may be that some of his 
suggestions were incorporated in the final act, but he 
was content with throwing his material into the common 
pot, out of which an admirable and lasting piece of legis- 

1 He was chairman of the Executive Committee of the National Citizens' 
League, whose ruling board was composed of Chicago business men. He also had 
valuable aid in this work from Professor W. A. Scott, of the University of 
Wisconsin, and Professor M. S. Wildman, of Stanford University. 
L- 160 



A PROPOSED BILL 161 

lation emerged. By presenting in this chapter his pro- 
posed bill * (for which, although aided by many others, he 
assumes all responsibility), it can easily be compared by 
the student with the Federal Reserve Act. Apart from 
technical banking provisions, of course the main interest 
centred on questions of organization and control, in- 
cluding the matter of centralization; elasticity and se- 
curity of note-issues; the elasticity of credit; the transi- 
tion from the old bond-secured circulation to the new 
systems; the co-operative holding of reserves; foreign 
banking; and clearings under a new system. 

§ 2. Out of the discussion on currency reform for the 
eighteen months preceding December, 1912, there had 
been reached on certain points a general agreement, which 
may be briefly summarized: 

1. The need of some co-operative agency for rediscounting 
commercial paper in time of pressure, in order to prevent panics. 
This would supplant the partial, voluntary work of clearing- 
houses in the past. 

2. A cessation of the present scattering of reserves, and their 
mobilization in the common interest of all banks. 

3. A control over the possible expansion of credit and the 
speculative use of idle funds. Control of the rate of discount. 

4. An elastic currency. The abolition of the system of 
bond-secured national bank notes. 

5. Bankers' acceptances of commercial paper to be allowed 
to national banks. 

6. The co-operative discount institution to be made the 
fiscal agent of the United States Treasury. 

7. Banking institutions to be established in foreign coun- 
tries to aid American trade. 

1 As to the charge that this bill was a disguised form of the Aldrich Bill, any 
one who had read both would see the falsity of the charge. C/. also the attack 
on this bill in the hearings before the Senate Committee on Banking, 63d Con- 
gress, 1st session, part 23, p. 1811, and part 38, p. 3013. 



162 BANKING PROGRESS 

Banking reform was tied up with currency reform, be- 
cause banks in this country provide a currency in the 
form of checks drawn on deposits, and because the ques- 
tion of the organization of credit is even more important 
than the issue of bank-notes. The unnecessary expense 
of obtaining credit under a bad banking system is borne 
by the borrower; the impossibility of getting loans in a 
time of stringency, or panic, shuts up factory and shop 
and falls most severely upon the wage-earner, who loses 
his employment. The defects of our banking and cur- 
rency system are obvious. 

It has long been seen that our currency is needlessly 
inelastic; that our credit system is even more danger- 
ously inelastic; that our large gold supply is ineffectively 
used; that the scattering of reserves forbids co-operative 
action by the banks in time of stress; that our rigid re- 
serve system even breeds panics; that State banks and 
trust companies are doing commercial banking, but with- 
out co-operation with national banks; that our inde- 
pendent subtreasury often attacks the reserves of banks 
at times of danger and works without businesslike 
economy and efficiency; that idle funds of banks drift 
to New York, and on call loans feed stock speculation; 
and that our trade is greatly hampered by lack of Ameri- 
can banking facilities in foreign countries. 

The defects of the present currency system are so ob- 
vious that there is a general consensus of opinion that 
something must be done. Legislation of some sort is 
inevitable. The Monetary Commission Plan has been 
politically antagonized. Some other plan, different but 
sound, must be brought forward; one whose control could 
not pass into the hands of an ambitious financial group. 
The present problem, therefore, is to find the best con- 
crete machinery for carrying out the points on which 
there is pretty general agreement. 



A PROPOSED BILL 163 

The emphasis of the opposition has been put on the 
fear of control by "Wall Street." It is a question, there- 
fore, whether any organization is possible, which would 
give the necessary oversight of the rediscounts in all parts 
of the country and the mobilization of the reserves to be 
directed in the common interest at the place of weakness 
and danger. In short, can we have an organization some- 
what like a central clearing-house, which would do for 
all the banks in the country what a clearing-house asso- 
ciation now does for the banks in one city? If so, the 
mechanism must be so simple that attempts to control 
it would be instantly perceived and be immediately frus- 
trated. In order to prevent possible domination, either 
considerable government control (which runs the risk of 
the greater danger of political control), or some division 
of the agencies of rediscount into local organizations, 
like present clearing-houses in the main cities, or trading 
centres, have been proposed. Perhaps, the true solu- 
tion lies between the two: the relegation of discount- 
making to branches or local institutions, with managers 
chosen by local boards, but who would be under super- 
vision by some general board; and, then such govern- 
ment supervision of this board as will assure freedom from 
any dominant financial control, but not going so far as 
to allow any interference from politics. Unity of action 
is indispensable; but so is freedom from domination by 
any selfish political or financial interests. 

§ 3. The reorganization of our credit system along 
democratic lines, at the same time that an elastic cur- 
rency is provided, demands nothing novel or disturbing, 
if it be accommodated to what has already been evolved 
out of our experience. In brief, this accompanying mea- 
sure is built up on the basis of our clearing-houses, in which 
we find there has grown up a mechanism to meet prac- 



164 BANKING PROGRESS 

tical difficulties which has not yet been overtaken or 
recognized by legislation. By building up the co-opera- 
tive discounting institutions upon the basis of the exist- 
ing clearing-houses of the chief trading centres of the 
country, we regularize extralegal and voluntary opera- 
tions which have grown to enormous importance. This 
bill simply attempts to keep pace with the past growth 
of experience; it does not overthrow; it supplements; 
and puts under legal direction what is now under private 
control, although quasi-public in character. 

Because of the lack of any regulation of credit, clear- 
ing-houses grew up of necessity. They perform two 
functions: (1) offsetting of checks drawn on or against 
the banks of a city, obviating all payments but balances; 
(2) from this co-operation the banks were led into a far 
more important co-operation, to help out a weaker mem- 
ber by combining resources and issuing clearing-house 
certificates when the credit system had broken down. 
This last was a rediscounting operation, turning banking 
assets into a means of meeting clearing-house balances. 

It has been charged that favoritism, or injustice, to 
banks has crept in, which could not be controlled, because 
clearing-houses were voluntary, unincorporated, extra- 
legal institutions. If so, this bill, which establishes dis- 
trict associations upon, and in lieu of, the chief clearing- 
house associations, would regularize all such operations 
and bring them under the supervision of the government. 

Because each district association is solely a discounting 
institution — devised to accomplish the reorganization of 
credit under the direction of law — it must have its own 
capital drawn from its membership in its own section. 
This arrangement localizes control in making loans, and 
requires democratic equality of treatment for every bank 
in a given district. It admits State as well as national 



A PROPOSED BILL 165 

banks. As banks in a city co-operate to secure protec- 
tion in the common interest, so the banks in a district 
(of which districts there may be five or more) co-operate 
to prevent selfish individualistic grasping for reserves in 
a time of alarm. In this way reserves are mobilized for 
a large section of the country so that no legitimate bor- 
rower in that territory need fail in getting credit and the 
means of payment, no matter what the stringency may 
be. Moreover, loans are limited to mercantile business, 
and not granted for stock-exchange transactions. 

Therefore, unity of action and equality of treatment 
throughout the country demand, in addition, much the 
same supervision of all the district associations as the 
individual banks receive in any one district. It is pro- 
posed to gain this end by a general supervisory board, 
called the treasury board, without any capital. In brief, 
the treasury board co-ordinates the various district asso- 
ciations much as a clearing-house committee co-ordinates 
the banks in any one city. Thereby the fangs are drawn 
from any objection based on the possibility of one cen- 
tralized institution, with a large capital, which might be 
dominated by "Wall Street" or by any selfish interest. 
The selection of this supervisory treasury board is made 
simple and plain enough to be free from all suspicion. It 
should provide for an equal representation by the three 
interests affected by the bill: (1) the bankers, (£) the bor- 
rowing business public, and (3) the government of the 
United States. 

Having thus provided for the reorganization of credit, 
the elasticity of the currency is obtained in connection 
with the discounting agencies, the district associations, 
but through the treasury board in such a way as to throw 
the limelight on the safety and management of the note- 
issues. It is admitted by all that the bond-secured na- 



166 BANKING PROGRESS 

tionai bank notes are inelastic and should be abolished. 
The first alternative is the retention of note-issues by 
the individual national banks, based solely on general 
assets. To avoid the "asset-currency" of individual 
banks, this bill takes the issue of notes away from the 
individual banks and places it in the hands of the treasury 
board under the close supervision of the government — 
while yet making them safe beyond question by a lien 
on all the assets of the district associations. Thus all 
the expense of redemption and of reserves is put upon the 
banks and not upon the government, while the super- 
vision is in the body in which the government is fully 
represented. This outcome is an obvious compromise 
between issues solely by banks and issues solely by the 
government. Such an adjustment may possibly be found 
in the accompanying bill. 

§4. An act to introduce into the banking and currency 
system of the United States elasticity of credit and circulation 
through the establishment of district associations and a trea- 
sury board. 

Be it enacted by the Senate and House of Representatives 
of the United States of America in Congress assembled: 

Sec. 1. That the Treasury Board of the United States be, 
and is hereby, established in Washington, in the District of 
Columbia, to consist of the Secretary of the Treasury, the 
Comptroller of the Currency and five other members, of whom 
four shall be appointed by the President of the United States. 
The fifth member shall be chosen by the Board as already con- 
stituted, and, with the approval of the President of the United 
States, he shall be the chairman of the Board and the manager 
thereof. The manager shall hold office for ten years unless 
previously removed for cause by the President, or by a two- 
thirds vote of the other members of the Board. The Manager 
shall receive a salary of twelve thousand dollars per annum. 
The four members appointed by the President shall hold office 
for five years, and may be reappointed, and each of said ap- 



A PROPOSED BILL 167 

pointees shall receive a salary of eight thousand dollars per 
annum. The term of service of members of the Treasury Board 
shall date from the day when this act shall go into force. 

Sec. 2. That there shall be established in any centre of 
trade in the United States which may be designated by the 
Treasury Board, a District Association for a term of twenty 
years from the date when this act shall go into effect. At the 
expiration of said term of twenty years, if this act has not 
been specifically repealed, said District Association shall con- 
tinue for another period of twenty years, and unless said act 
has been repealed at the end of a second period of twenty 
years, said Associations shall continue in existence until said 
act may be repealed; Provided, however, that Congress may 
alter or amend the provisions of this act to take effect at the 
end of successive periods of ten years after its passage. 

Sec. 3. Each District Association shall have an authorized 
capital, divided into shares of $100 each, equal in amount to 
10 per cent of the paid-in capital and surplus of all qualifying 
banks constituting its membership, as hereinafter indicated, 
of which capital 5 per cent must be paid in in cash before it is 
authorized to begin business. No District Association shall be 
given a certificate of incorporation, or be allowed to begin 
business by the Treasury Board, unless the total amount of 
its paid-up capital shall be equal to, or shall exceed, $10,000,000. 

Sec. 4. Within thirty days after the passage of this act, 
the Treasury Board shall inform each national bank and each 
bank and trust company incorporated under the laws of any 
State or of the District of Columbia of the conditions prescribed 
for membership in said District Associations. Said Treasury 
Board shall designate the cities, or trade centres, in which a 
District Association shall be placed, and define the territory 
of each, indicating the District Association of which each quali- 
fying bank or trust company shall be a member. 

Sec. 5. In order to qualify as a member of a District Asso- 
ciation, a national bank, or a bank or trust company doing a 
commercial banking business incorporated under the laws of 
any State or of the District of Columbia, must conform to the 
following requirements : 

1. It must have subscribed to the stock of its District Associa- 
tion, as designated by the Treasury Board, an amount equal 



168 BANKING PROGRESS 

to 10 per centum of its paid-in capital and surplus; and it 
must have paid in, in such manner as may be indicated by said 
Treasury Board, in full legal tender money or national bank 
notes, one-half of the capital stock thus subscribed. 

The subscriptions of a bank or trust company incorporated 
under the laws of any State or of the District of Columbia to 
the capital stock of a District Association shall be made sub- 
ject to the following conditions: 

That (a) if a bank, it shall have a paid-in and unimpaired 
capital of not less than that required for a national bank in 
the same locality; and that (6) if a trust company, it shall have 
an unimpaired surplus of not less than twenty per centum of its 
capital, and if located in a place having a population of six 
thousand inhabitants or less, shall have a paid-in and unim- 
paired capital of not less than fifty thousand dollars; if located 
in a city having a population of more than six thousand in- 
habitants and not more than fifty thousand inhabitants, shall 
have a paid-in and unimpaired capital of not less than one 
hundred thousand dollars; if located in a city having a popula- 
tion of more than fifty thousand inhabitants and not more 
than two hundred thousand inhabitants, shall have a paid-in 
and unimpaired capital of not less than two hundred thousand 
dollars; if located in a city having a population of more than 
two hundred thousand inhabitants, and not more than three 
hundred thousand inhabitants, shall have a paid-in and un- 
impaired capital of not less than three hundred thousand dollars; 
if located in a city having a population of more than three hun- 
dred thousand inhabitants and not more than four hundred 
thousand inhabitants, shall have a paid-in and unimpaired 
capital of not less than four hundred thousand dollars; and if 
located in a city having a population of more than four hundred 
thousand inhabitants, shall have a paid-in and unimpaired 
capital of not less than five hundred thousand dollars. 

2. It must carry such reserves as are required in Sec. 28 of 
this act, comply with all the regulations regarding reports and 
examinations, or any other regulations imposed by this act or 
involved in the execution of its provisions, and promptly meet 
all its obligations to its District Association. 

3. If a national bank, it must present a certificate from the 
Comptroller of the Currency that its affairs have been in good 



A PROPOSED BILL 169 

order for the preceding twelve months; if a State bank or trust 
company, it must present a similar certificate from the banking 
department of its State. 

4. Any qualified bank or trust company may withdraw from 
membership in its District Association by giving 60 days notice 
in writing of its intention to withdraw, and by meeting all its 
obligations to the Association, including the payment of its 
pro rata share of any losses that may have occurred. Said 
Association shall be allowed four months after the actual with- 
drawal in which to repay to said withdrawing member its con- 
tribution to the capital stock of said Association; but in no 
case shall more than the amount paid in to the capital stock 
of said Association be returned. 

5. Upon the fulfilment of the conditions herein stated, the 
Treasury Board, through its duly authorized officer, shall issue 
to each District Association a certificate of incorporation, 
for a term of twenty years from the date when this act shall go 
into effect, duly countersigned by the Manager of the Treasury 
Board and the Comptroller of the Currency. 

Sec. 6. Upon the issue to each District Association of said 
certificate of incorporation, as above described, said District 
Association shall become, and is hereby created, a body cor- 
porate, and as such and by that name, to which shall be at- 
tached the number of the District, shall have power: 

First: To adopt and use a corporate seal. 

Second : To have succession for a period of twenty years from 
the date of this act. 

Third: To make all contracts necessary and proper to carry 
out the powers granted to said District Association by this 
act. 

Fourth: To sue and be sued, complain and defend, in any 
court of law or equity, as fully as natural persons. 

Fifth: To select or appoint directors and officers in the 
manner hereinafter provided and define their duties. 

Sixth: To adopt by its Board of Directors by-laws not in- 
consistent with this act, regulating the manner in which its 
property shall be transferred, its general business conducted, 
and the privileges granted to it by law exercised and enjoyed, 
subject to the authority of the Treasury Board, as may be stated 
in this act. 



170 BANKING PROGRESS 

Seventh: To purchase, acquire, hold and convey real estate 
as hereinafter provided. 

Eighth: To exercise by its Board of Directors or duly au- 
thorized committees, officers, or agents, subject to law, all the 
powers and privileges conferred upon said District Association, 
subject to the authority of the Treasury Board, as may be 
stated in this act. 

Ninth: To provide as far as possible for the clearing of checks 
and drafts between different qualifying banks and between dif- 
ferent District Associations. 

Sec. 7. The Board of Directors of each District Associa- 
tion shall be elected as follows: 

The subscribing banks in each district, and exclusive of the 
banks which are members of the clearing-house of the city in 
which the District Association is situated, shall be divided by 
the Bank Commission or by the Treasury Board territorially into 
six groups, each of which groups shall elect one director; each 
bank having one vote. 

Three additional directors shall be named by the clearing- 
house of the city in which the District Association is situated. 

The Treasury Board shall select five more directors from a 
list of fifteen nominees chosen by the nine directors already 
elected, which nominees shall not be officers of any banking 
institution (directors of banks not being regarded as officers) 
and who shall represent the chief agricultural, industrial and 
commercial interests of the district. 

The fourteen directors thus chosen shall select from outside 
their number a person who shall constitute the fifteenth mem- 
ber of the Board and be its presiding officer and manager of the 
District Association, provided this choice be ratified by the 
Treasury Board. 

The term of office of the manager shall be five years, but he 
may be at any time removed for cause by the Board of Directors. 

The Board of Directors of each Association shall also ap- 
point an Executive Committee of not less than three nor more 
than five from its members, of which the manager shall be ex 
officio chairman. 

An Examining Board shall be appointed by the Board of 
Directors of the District Association, who shall examine into 
and report on the condition of the qualified banks within the 



A PROPOSED BILL 171 

district assigned to each, and shall furnish to the District Asso- 
ciation all information necessary for the proper selection of the 
paper presented for discount. 

§ 5. The provisions of the bill regarding discounts 
are as follows: 

Sec. 8. The business of the District Associations shall be: 
(a) To receive from any qualifying institution within its 
district deposits of lawful money and national bank notes. 

(6) To discount to the extent that its resources and the pro- 
visions of this act permit for properly qualified institutions 
paper of the following kinds: 

(1) Such notes and bills of exchange as have been received 
in the course of business, which bear the indorsement of the 
institution presenting them for discount and which mature 
in not more than 60 days, excepting such notes and bills of 
exchange as are issued or drawn for the purpose of carrying 
stocks, bonds, or other investment securities; 

(2) Acceptances of national banks made in pursuance of the 
provisions of Sec. 10 of this act, or acceptances of other quali- 
fied banks, which are based on travellers' credits or on the ex- 
portation, or importation of the products of the soil, mines, 
or of manufacture, and which mature in not more than 90 
days and bear the signature of at least one bank in addition 
to that of the acceptor; 

(3) The direct obligations of qualified institutions under the 
following conditions: Application for the privilege of making 
such discounts, designating the amounts, the collateral offered 
and the institutions applying for them, must be made to the 
Manager of the Treasury Board. If in his opinion such dis- 
counts are required in the interests of the public, and if such 
opinion is approved by a majority vote of the Treasury Board, 
and, also, if such opinion is approved by the Secretary of the 
Treasury, the privilege may be granted, Provided the collateral 
pledged shall be of unquestioned soundness; and that the 
amount of the loan shall not exceed 75 per cent of the market 
value of the securities pledged. 

The total amount of discounts granted to any one qualified 



172 BANKING PROGRESS 

bank by any District Association shall not exceed a sum equal 
to the amount of the capital of said borrowing bank. 

"Whenever the amount of discounts granted to any one quali- 
fied bank by any District Association shall equal 50 per cent 
of its paid-in capital, any discounts in excess of said 50 per 
cent shall be charged a commission, as follows: between 50 
and 60 per cent, one per cent; between 60 and 80 per cent, 
two per cent; between 80 and 100 per cent, three per cent. 

Sec. 9. The functions of rediscounting, or the issue of 
clearing-house certificates, by existing or future clearing-house 
associations, are hereby forbidden, it being assumed that such 
functions of existing clearing-house associations are exercised 
solely by the District Associations. 

Sec. 10. National banks are hereby authorized to accept 
drafts or bills of exchange drawn upon them, having not more 
than four months to run, accompanied by the documentary 
evidence of the nature of the transaction which must be based 
on the movement of goods from the producer to the consumer, 
and were not drawn for the purpose of carrying stocks, bonds 
or other investment securities. 

Sec. 11. Each District Association shall have authority to 
fix the rates of discount from time to time, which rate when so 
fixed shall be published, and shall be uniform within its District, 
Provided, that the Treasury Board shall have authority both 
to veto any proposed changes, or to order changes, in rates. 

Section 8 of the bill authorizes the district associa- 
tions to render two kinds of services to the qualifying 
institutions in their districts, namely, the administra- 
tion of their reserves, and rediscounting. 

In the description of the paper which the district asso- 
ciations are to be permitted to discount, described in 
(b) (1), (2), and (3), the following points are important: 
The limitation of discounts to paper which arises from 
the general movement of goods from producer to con- 
sumer; the permission to discount both promissory notes 
and bills of exchange which answer this description; the 
requirement that all such paper must bear the indorse- 



A PROPOSED BILL 173 

merit of the bank presenting it for discount; and that it 
must mature in sixty days or less. It is undesirable to 
introduce rigid definitions into the law which lead to 
difficulties that the experience with the National Banking 
Act shows have often arisen. Inevitably much must be 
left to the management. The phraseology used in Sec- 
tion 8 defining the paper has been the result of much 
consultation with practical bankers. 

Some persons have doubted the advisability of permit- 
ting the district associations to discount promissory notes 
on the ground that such permission would allow, and 
perhaps encourage, the continuation of the confusion of 
commercial and investment banking now almost uni- 
versal in this country, while the limitation of discounts 
to commercial bills of exchange and bank acceptances of 
a commercial character would discourage existing bank 
practices and help to remove this confusion by forcing 
banks to put pressure upon their customers for the pur- 
pose of bringing back into use again the old commercial 
bill of exchange. It would probably be difficult, how- 
ever, and perhaps impossible to change business habits 
in this respect immediately, and if so, the district associa- 
tions should not be prohibited from discounting promis- 
sory notes in the meantime. The desirability of setting 
some limit to the length of time during which discounts 
of this character are to be permitted, however, is worthy 
of serious consideration. 

It is desirable that the district associations should con- 
fine their discounts to as short-term paper as possible, 
and sixty days seems to be a reasonable period both from 
the standpoint of the district associations and that of 
their customers. Of course this limitation does not rule 
out paper that has been drawn for longer periods. The 
requirement is that such paper must be within sixty days 



174 BANKING PROGRESS 

of maturity before the district associations can redis- 
count it. 

In some respects the permission granted in (b) (3) to 
discount the direct obligations of qualifying institutions 
is out of harmony with the spirit and general purpose 
of this act, which is to draw a sharp line of distinction 
between commercial and investment banking, and to 
connect the issue of currency with the former and to dis- 
connect it from the latter. Under very strict limitations 
this section permits loans on investment, instead of com- 
mercial, collateral, and thus permits the issue of treasury 
notes and the expansion of bank credits against invest- 
ment securities. 

The danger of this provision consists in the fact that 
it leaves open a door of escape to banks that violate the 
principles of sound commercial banking. But in times 
of crises it would be difficult, if not impossible, to refuse 
such a bank the privilege described in this section. On 
the other hand, investment banking is not only perfectly 
legitimate, but just as necessary as commercial banking, 
and the two kinds are now, and are bound to continue 
to be, carried on together by most of the banks and trust 
companies of the country. It is possible that a bank or 
trust company whose practices had been conservative 
and beyond reproach, might find itself, as a result of 
very unusual and unexpected combinations of circum- 
stances, in need of more cash than it could get through 
the rediscount of its commercial paper. Should such a 
bank be denied relief by its district association? It is 
in the belief that it should not, and that the granting of 
such relief under the limitations here imposed would not 
be dangerous, that this section has been included. 

The purpose of Section 10 is to provide a form of com- 
mercial bill of the widest possible currency, namely, the 



A PROPOSED BILL 175 

banker's bill already in such general use on European 
markets. It should be noted that the bill which it is 
the purpose of this section to create is not a finance bill 
(i. e., a bill drawn not against a shipment of goods or 
securities, but being in itself essentially a loan), but a 
commercial bill of the same general character as the one 
described in Section 8. Such a bill would have to be 
accompanied by the same kind of evidence of its real 
commercial character as the acceptance or personal note 
of a merchant or manufacturer. Bills of this character 
could be readily negotiated on foreign markets, and could 
be used by the treasury board in replenishing its reserves 
in case of need. They would also be purchased by banks 
in this country whose loan funds were in excess of local 
needs and would probably take the place of bonds in 
the secondary reserves of banks. 

Section 29, given later in the bill under investments, 
simply authorizes the district associations to make use 
of idle funds in case a sufficient amount of paper does 
not come to them in the form of rediscounts. In other 
words, it is permitted to solicit as well as to accept paper 
for discount. 

The subject of a uniform rate of discount is treated in 
Section 11. In the discussion to date, objections have 
been made to a rate uniform to the whole country, fixed 
by a central agency in Washington, on the ground that 
in our big country there are great differences in banking 
and industrial conditions, and in the local supply of 
capital, consequently causing legitimate differences in 
the rates of interest in different sections. Then, too, if 
one rate were fixed for all sections, a rate, e.g., current 
in New England, would encourage expansion in a distant 
Western district, and draw capital away from legitimate 
uses in conservative districts. In any case, however, 



176 BANKING PROGRESS 

the rate in this bill is one only between the rediscounting 
district association and its member banks. It does not 
change the relations between the individual bank and its 
customer. But while recognizing that general differences 
in levels of interest may exist in different parts of the 
country, and that each district association may fix the 
rate within its district (subject to approval by the treasury 
board), this rate must be uniform to every bank within 
a given district. Thus, while securing equality of treat- 
ment for all banks, big or little, within any one district, 
it provides a suitable flexibility for differing conditions 
in a large country by allowing different rates in different 
districts. 

§ 6. The functions of the treasury board are given in 
the following sections, additional to Sections 1 to 11 : 

Sec. 12. The Treasury Board shall appoint a Board of Ex- 
aminers, consisting of three members, to report at any time 
upon the conditions of credit, the kind of business done, and 
the proper conduct of the discounts at each District Associa- 
tion, or of any individual bank; and said Treasury Board may 
authorize the employment of suitable assistance, if needed, 
for this work of examination. 

Sec. 13. To assist the Treasury Board in the performance 
of its duties, there shall be established an Advisory Board to 
consist of representatives of the District Association, one such 
representative to be appointed by the Board of Directors of 
each Association, and ten other persons to be selected by said 
representatives from a list of twenty-one nominees named, 
seven each respectively by three committees representing re- 
spectively the leading agricultural, industrial and commercial 
organizations of the United States. The method of appoint- 
ing said committees shall be prescribed from time to time by 
the by-laws of the Treasury Board. 

The Advisory Board shall hold regular monthly meetings 
and special meetings whenever called by the Treasury Board. 



A PROPOSED BILL 177 

Full reports of the operations of the Treasury Board during the 
preceding month shall be presented by its manager, and any 
member of the Advisory Board may offer criticisms or sugges- 
tions. The final decision on all matters, however, shall remain 
with the Treasury Board. 

At all meetings of the Advisory Board, a quorum shall con- 
sist of a majority of all members. Each member shall be re- 
imbursed for his reasonable travelling and other necessary ex- 
penses for attendance at each meeting on vouchers approved 
by the Treasury Board. 

Sec. 14. Said Treasury Board shall establish an office with 
each District Association, under charge of its own official, in 
which may be held such papers, securities, Treasury notes, or 
cash of any sort, the property of said Treasury Board, as may 
be deemed expedient in connection with daily transactions, or 
with any transfer of funds from one District Association to 
another, or in the redemption of its Treasury notes. 

Sec. 15. The expenses of the Treasury Board shall be paid 
by the District Associations out of their gross receipts in such 
a manner and at such times as the Treasury Board shall direct. 
Each Association shall pay such a portion of said expenses as 
its capital and surplus bear to the aggregate capital and sur- 
plus of all the Associations. 

The board established in Section 1 is assigned, in sub- 
sequent sections, administrative and supervisory func- 
tions only, and hence needs no capital. The period of 
its corporate existence is made twenty years to corre- 
spond with that of the district associations described in 
Section 2. This period is long enough to give the insti- 
tution a fair trial and not so long as to commit the 
country unduly to an untried experiment. It should be 
observed that no legislation is required to continue its 
existence beyond this period. It is possible that the 
right to revise the charter more frequently than once in 
twenty years should be reserved. The Canadian banking 
act may be amended by Parliament every ten years. 

The name, treasury board, is not inappropriate inas- 



178 BANKING PROGRESS 

much as the secretary of the treasury and the comptroller 
of the currency are the ex officio, and thus the only per- 
manent, members of it, and inasmuch as four other mem- 
bers are to be named by the President. This name has 
the advantage of suggesting the connection of the gov- 
ernment with it, and thus of inspiring public confidence 
in the notes it is authorized to issue. 

In Section 11 the treasury board is given supreme au- 
thority over rates of discount, but at the same time an 
initiative in their determination is granted to the district 
associations. Should circumstances seem to demand, 
it is possible under the operations of this section that 
different rates might prevail in different sections, but at 
the same time this condition of things could be pre- 
vented or modified at will by the treasury board. This 
arrangement is probably safest for us under present con- 
ditions. Since the district associations are to do the dis- 
counting, under ordinary circumstances they will be in 
closest touch with the market and best fitted to fix rates 
in their respective districts. On the other hand, the 
treasury board will alone be in possession of all the data 
relative to the state of the gold reserves and the conditions 
of credit throughout the country as a whole, and should, 
therefore, have the power to order such changes in rates 
as these conditions demand. If uniform rates through- 
out the country prove to be feasible and desirable the 
treasury board can establish them. On the other hand, 
if such uniformity should threaten overexpansion in cer- 
tain sections, and the undue concentration of the bank- 
ing resources of the country there, the power to prevent 
it rests likewise with the treasury board. 

As defined by this bill, it is the function of the treasury 
board to act as an instrument of control and co-operation 



A PROPOSED BILL 179 

for the district associations. The board of examiners 
provided for in Section 12 is an important and essential 
part of the machinery for these purposes. The treasury 
board must have direct access at all times to the books of 
the district associations and be in constant touch with 
them. For these purposes written reports made to the 
board by these associations are, of course, necessary, but 
inadequate. An examining board such as is here pro- 
vided would be the strong arm of the treasury board in 
the most essential features of its work. 

The treasury board (Section 15) will have no inde- 
pendent source of income. The commercial paper, ac- 
ceptances, and bonds transferred to it, as well as the gold 
and other forms of money, will remain the property of 
the district associations making such transfers, and the 
interest earned on them will be theirs. In all of its 
operations the treasury board will be simply their agent, 
and its expenses will therefore be properly chargeable to 
them. 

In brief the functions of the treasury board may be 
summarized as follows: 

1. To supervise as a body of experts the operations of the 
District Associations while leaving all direct discounting to the 
Associations; in fact, to represent the United States as a super- 
vising body over banking and currency. 

2. To advise against inflation or speculation in any one 
District, should it arise, and to have power for that purpose 
over the rate of discount. 

3. To have the power to examine into the conduct of any 
District Association, or of any individual bank. 

4. To act as an issue-agency for all the District Associations 
in common, and to hold and account for the protection behind 
the Treasury notes. 

5. To act in the transition period as the agent for refunding 



180 BANKING PROGRESS 

the 2 per cent United States bond (with the circulation priv- 
ilege) into 3 per cents (without the circulation privilege) and 
the gradual change of bonds into gold behind the Treasury- 
notes. 

6. To bring about the substitution of Treasury notes for all 
national bank notes. 

7. To publish combined and separate accounts for all Dis- 
trict Associations once a week, and also weekly statements of 
the issue of Treasury notes and the assets behind them. 

8. To watch over the gold reserves through the agencies of 
the District Associations, or to import gold, if needed. 

In order to obtain the guidance and experience of men 
representing all parts of the country, an advisory board 
has been created to work with the treasury board. Local 
or sectional points of view will be mingled in the inter- 
ests of the country as a whole through this agency. 
Moreover, there will be better opportunity to compare 
conditions of business and credit in all parts of the 
United States; and to receive advice as to making pos- 
sible changes in the rate of discount. 

§ 7. The district associations provided for in Sec- 
tions 2-7 constitute the characteristic features of the 
plan upon which this act has been constructed, namely, 
that of the establishment of a number of regional banks, 
which, through the treasury board, will co-operate in 
matters of national import, such as the issue of notes, 
the administration of specie reserves, and the retirement 
of the national bank and the United States notes. Each 
regional bank will serve as a rediscount and reserve 
centre for the banks and trust companies of its district, 
and, through its connection with the treasury board, will 
make these banks and trust companies parts of a national 
organization through which our currency and credit 
system may be properly regulated and controlled. The 



A PROPOSED BILL 



181 



relation of the district associations to the treasury board 
may be best expressed by the accompanying diagram: 







& 



A= Treasury board, or the agency of B, B, etc. An agency for issuing notes, 
holding protection behind notes, having no capital, having general supervisory 
powers over rate of discounts, etc., and under close government supervision. 

B, B, B, etc. = District associations, rediscounting agencies for the indi- 
vidual banks, C, C, C, etc. 

D, D, D — Reserves of B, which might be the notes of the treasury board A. 
The reserves of C, C, C should not be treasury board notes, but gold or lawful 
money. This rule would force treasury notes back for redemption when not 
needed by the public. 

A, A, etc. = Offices of A at each district association, where notes would be 
redeemed, or commercial paper exchanged for notes. 

The bill provides for the performance of the chief func- 
tions usually possessed by a central bank through local 
institutions centrally supervised and controlled in so far 
as the proper functioning of our national currency and 
credit system requires such supervision and control. 
The capital of these associations should be proportional 
to the amount of business they are likely to be called 
upon to perform. Inasmuch as they will have as working 
funds, in addition to the amounts paid in by stockhold- 
ers, the reserves deposited with them and the proceeds 
of collections, and inasmuch as the proceeds of redis- 
counts will, to a considerable extent, be left on deposit to 
be used for clearing and transfer purposes, it seems prob- 
able that a capital stock equal to 10 per cent of the cap- 
ital and surplus of the banks and trust companies of the 
district will be entirely adequate. 



182 BANKING PROGRESS 

The size of the districts must be determined chiefly 
by the convenience of banks and this will depend to a 
considerable extent upon facilities for transportation. 
It seems clear, however, that no district should be so 
small as to be unable to supply the association with a 
capital of at least $10,000,000. Probably most of the 
districts would be much larger than this, and in some 
cases it will probably be necessary to have several redis- 
count offices under the supervision and control of one 
district association. Inasmuch as it is wise to start with 
a small number of associations so that each would com- 
mand respect for stability and resources, and inasmuch 
as one of these would cover a considerable geographical 
area, there would be additional reasons for establishing 
agencies of an association within any one district for 
convenient operation of its business. 

The separate incorporation of each district associa- 
tion (Section 6) will be necessary since each is to be an 
independent organization with a capital of its own feder- 
ated with other independent organizations of the same 
kind. It should be noted that among its corporate powers 
is that of acting as a clearing institution. The manner 
in which this function is to be performed is described in 
a subsequent section. 

In the plan here suggested (in Section 7) for the choice 
of the directorates of the district associations, three de- 
siderata have been held in mind, namely, efficiency, demo- 
cratic control, and proper connection with the treasury 
board. In order to be efficient, these boards must con- 
sist of men who know intimately the agriculture, com- 
merce, and industry of the section. The bankers are best 
fitted to select such men, since they alone know them all 
and know them intimately, especially in their financial 
relations, which are here most important. It is for this 



A PROPOSED BILL 183 

reason and because other practicable methods did not 
suggest themselves that the actual selection of some and 
the nomination of all the directors is put into the hands 
of organized banks and clearing-houses. 

Democratic control is secured, firstly, by providing for 
representation of all the interests concerned, the local 
banks whose paper is to be discounted and whose reserves 
are to be administered, the clearing-house of the city in 
which the main office of the association is located (which 
is interested in the same way that other banks are, and 
additionally because the association is to conduct inter- 
municipal clearings), the farmers, merchants, and manu- 
facturers of the district who must use the banks and trust 
companies in the e very-day conduct of their affairs, and 
the treasury board, which represents the government 
and the people as a whole and has general controlling 
and supervising powers over all the associations. Sec- 
ondly, no one of these groups of interests is given con- 
trol of the institutions; no action can be taken without 
agreement between at least two of them; and, thirdly, 
absolute equality between the voting institutions is se- 
cured, the number of banks and trust companies in each 
voting group having equal power, and each bank and 
trust company within each group being given the same 
voting rights and privileges regardless of its size. In 
such an organization big banks could have no advantage 
over little ones, and no kind of coercion could be exerted. 

The treasury board cannot perform its functions un- 
less there is complete harmony of action and policy be- 
tween it and the district associations. This is here se- 
cured by giving said board the power to choose as directors 
five representatives of the agriculture, commerce, and in- 
dustry of the section from a list of fifteen candidates se- 
lected by the other directors. If it is thought best to 



184 BANKING PROGRESS 

increase the power of the treasury board, a further pro- 
vision might be added to the effect that in case five per- 
sons satisfactory to said board could not be found among 
the fifteen first nominated, other nominations must be 
made until a sufficient number of satisfactory persons 
are found. 

The examining boards provided (in Section 7) will con- 
stitute a very important part of the machinery of the 
district associations. Their chief functions will be to 
aid in the selection of the paper offered for rediscount 
and in securing the enforcement on the banks and trust 
companies of the country of the regulation and practices 
prescribed by this act and involved in its operations. 
Banks will also need support and assistance in the proc- 
ess of putting their business on a commercial paper basis, 
and these examining boards should be of great assistance 
in this direction. The efficiency of such boards has been 
demonstrated by the clearing-house associations of our 
large cities, and there is no good reason for believing that 
boards here provided for would not be equally efficient. 

§ 8. In regard to note-issues this bill went further 
than political opinion in Congress was likely to go. 
Nevertheless, European experience has pointed out 
methods by which we might have provided an ideal sys- 
tem of our own. Consequently, the provisions of the 
bill on this subject are in advance of what might be politi- 
cally possible. The sections on note-issues are as follows: 

Sec. 16. At the office of the Treasury Board in Washing- 
ton shall be established an Issue Department, and the accounts 
of the Issue Department shall be separately kept and so pub- 
lished weekly. 

Sec. 17. To the Department of Issue of the Treasury 
Board shall be transferred by the District Associations all the 



A PROPOSED BILL 185 

United States notes and national bank notes paid in for capital 
stock, or received on deposit by the District Associations from 
any source; and, also, all gold coin and gold certificates re- 
ceived by the District Associations which are not retained for 
their daily demands. In return, said Department of Issue 
shall issue to the respective District Associations a like amount 
of the notes of the Treasury Board in denominations to be fixed 
by said Treasury Board, and designated "Treasury Notes," or at 
the option of said Association credit the amount to its account. 

The Treasury of the United States shall likewise transfer to 
the Treasury Board in exchange for Treasury notes all the 
United States notes and national bank notes that come into 
its possession. 

The United States notes and national bank notes thus re- 
ceived by said Department of Issue shall not be paid out again, 
but shall be held until disposed of in the manner hereinafter 
indicated. 

Sec. 18. The national bank notes received by the Issue 
Department of the Treasury Board shall be debited in a special 
account to the banks which issued them and the amounts thus 
debited shall from time to time be certified to the District Asso- 
ciations with which such banks do business. Whenever any 
District Association has received from such a bank United 
States bonds to secure circulation in accordance with the pro- 
visions of Section 23 of this act, it shall transfer to the Treasury 
Board an amount of such bonds equal to the notes debited as 
above indicated to the account of that bank on the books of 
the Issue Department of the Treasury Board, and said bonds 
when so received shall be credited at par to the note account 
of said bank, and the notes of said bank in like amount be can- 
celled and destroyed. 

Sec. 19. The Treasury Board may also receive for the 
Issue Department from District Associations selected com- 
mercial paper of the kind previously described (Section 8) 
which has not more than thirty days to run, in amounts re- 
ceived from the several District Associations in proportion to 
the needs and condition of business of each District, as ad- 
judged by said Treasury Board, and said Issue Department 
shall issue to the respective District Associations in return an 
amount of its Treasury notes equal to 95 per cent of the value 



186 BANKING PROGRESS 

of said commercial paper, Provided that at all times the amount 
of gold certificates, gold coin, or gold bullion in the reserves of 
said Issue Department shall not be less than one-third of the 
total Treasury notes issued, and Provided that the amount of 
commercial paper thus received from any one District Asso- 
ciation shall not exceed twice the amount of its capital and 
surplus. 

Sec. 20. The notes of said Treasury Board shall be redeem- 
able on demand in gold coin, or gold certificates, at the option 
of the holder at its office in Washington or in its office at any 
District Association. 

All notes redeemed by the Department of Issue shall be can- 
celled and not reissued. 

To provide the means for redemption in gold, the Treasury 
Board may exchange its Treasury notes for any gold coin, 
gold certificates, or gold bullion in the hands of the District 
Associations; or it may present any United States notes in its 
reserves to the Treasury of the United States, which shall give 
gold in redemption of said notes, Provided, however, that the 
Treasurer of the United States shall not pay out the notes thus 
redeemed except to the said Treasury Board in exchange for 
gold coin, or gold certificates, which exchange shall be made at 
the option of the said Treasury Board as soon as its gold hold- 
ings shall warrant such exchange; or, it may offer any of the 
United States bonds held by it, not having the circulation 
privilege, under the refunding clause hereinafter described 
(Section 24), for sale for gold, or it may use them as a basis 
for a loan of gold, upon such terms as may be agreed upon 
jointly by the Executive Committee of said Treasury Board 
and the Secretary of the Treasury; or, it may receive from the 
District Associations in return for its Treasury notes, the pro- 
ceeds in gold arising from the discount or hypothecation by 
the District Associations of any gold exchange, or any bills of 
exchange, in the hands of said District Associations; or, it 
may purchase in exchange for treasury notes from District 
Associations foreign bills of exchange; and it may sell in foreign 
markets for gold any of said bills of exchange, or any of the 
commercial paper or acceptances in its possession. 

Sec. 21. The circulating notes of the Treasury Board shall 
be received at par in payment of all taxes, excises, and other 
dues to the United States, and for all salaries and other debts 



A PROPOSED BILL 187 

and demands owing by the United States to individuals, firms, 
corporations, or associations, except obligations of the Gov- 
ernment which are by their terms specifically payable in gold, 
and for all debts due from or by one bank or trust company to 
another, and for all obligations due to any bank or trust company. 
Sec. 22. In addition to the cash reserves, the United States 
bonds, and the commercial paper held by the Issue Depart- 
ment of the Treasury Board, held as security for the redemp- 
tion of said Treasury notes, the aforesaid Treasury notes emitted 
by said Issue Department shall be a first lien on all the assets 
of the several District Associations in the proportion that the 
capital stock of any one District Association bears to the total 
capital stock of all the associations. 

In explanation of the plan of note-issues thus pre- 
sented, various considerations should be kept in mind. 

Elasticity in our hand-to-hand currency is one of the 
chief objects to be attained through the treasury board. 
Contraction as well as expansion is an essential of elas- 
ticity. A part of the machinery for that purpose is pro- 
vided in Section 20. The redemption of the treasury 
notes in gold is not only a means of maintaining their 
constant parity with gold coin, but of reducing the volume 
of the currency in case it exceeds the needs of commerce. 
Gold is a commodity useful in the arts as well as in the 
medium of exchange, and the presentation of treasury 
notes for gold and the use of the gold thus obtained for 
non-monetary purposes or for hoarding would reduce the 
volume of the circulating medium. 

Another and still more efficient means to the same end 
is the withdrawal at maturity by the district associations 
of the commercial paper transferred to the treasury 
board (see Section 19). In case the circulating medium 
became excessive, such withdrawals would exceed in 
amount the current transfers of commercial paper to 
the treasury board in exchange for notes, and the only 
means of meeting this excess would be the transfer to 



188 BANKING PROGRESS 

the treasury board of an equivalent amount of the 
treasury notes or of legal-tender money withdrawn from 
circulation. The treasury notes, when withdrawn, would 
be cancelled and destroyed, and the legal-tender money 
held in reserve. 

At this point the question may be raised (Section 21) 
whether the treasury notes should be made legal tender 
for all purposes except payments by the treasury board 
and the district associations. There seems to be no good 
reason for giving them this quality. Being redeemable 
in gold on demand, they will circulate readily without 
being legal tender, and it is desirable to encourage in 
every way their presentation for redemption whenever 
there is the least redundancy; and depriving them of the 
legal-tender quality to some extent at least offers such 
encouragement. 

The security of the treasury notes issued under the au- 
thority of this act will be beyond question (Sections 19- 
22). They will be completely covered by gold and other 
forms of legal-tender money, by United States bonds, 
and by short-time commercial paper which has passed 
the scrutiny of both district associations and the treasury 
board, and which bear the indorsement of the institu- 
tions which presented them for rediscount. Losses on 
such paper, if any should occur, would fall upon the dis- 
trict association which deposited it with the treasury 
board as security for notes issued. It is not possible 
that such losses would be large enough to affect appre- 
ciably the resources of any association. The first lien 
on assets here provided for is probably unnecessary, but 
it will put beyond question the public confidence in the 
safety of the notes. In the end, with the gradual dis- 
posal of United States notes and bonds, the protection 
to the notes would tend to become more largely gold and 
commercial paper. 



A PROPOSED BILL 189 

Section 19 provides for a minimum gold reserve of 
one-third against note-issues. All issues not covered by 
gold would be covered by the special reserves of green- 
backs and national bank notes held by the treasury 
board pending their retirement, by bonds acquired in 
the manner indicated in the preceding section, and by 
commercial paper maturing in sixty days or less. The 
treasury board could enlarge its gold reserve at any time 
by selling its bond holdings, by transferring greenbacks 
to the treasury for redemption, by selling abroad such 
of its commercial paper as might be there negotiable, by 
collecting its foreign bills at maturity or rediscounting 
them on foreign markets, or by borrowing gold on the 
security of its bonds. 

The transfer of commercial paper to the treasury board 
as herein provided would constitute the principal means 
in the possession of the district associations of replenish- 
ing their cash resources. Another means would be the 
presentation to the treasury board of treasury notes for 
redemption in gold, and a third would be the deposits of 
cash made with the associations. 

Maintaining one reserve for both demand-liabilities — 
notes and deposits — was the characteristic of early bank- 
ing in the United States when checks drawn on deposits 
were much less used than bank-notes. The two United 
States Banks were types of this kind, as were also the 
banks under State charters before 1838. Such a type of 
bank reflected the rural conditions of the time and the 
habit of using chiefly notes or coin as a medium of ex- 
change. After the New York Free Banking Act of 1838, 
separate assets were pledged for the notes. This plan was 
improved upon and adopted into our national banking sys- 
tem; but notes secured by United States bonds, while 
safe, proved wholly inelastic. The Bank of France is of 
the same type as were the two United States Banks of 



190 BANKING PROGRESS 

our early history, having but one reserve for both notes 
and deposits; and for the very good reason that in France 
notes, not checks drawn on deposits, form the chief 
medium of exchange. Much the same is true of the 
Reichsbank. 

The development of our own banking habits and the 
characteristics of our business methods require a system 
different from that of these Continental banks. If any 
European example may suggest methods to us, it would 
be that of Great Britain, which is the only other country 
that has a fully developed credit system like our own; 
it is the only other country that uses chiefly the deposit- 
currency, instead of notes, as a medium of exchange. 
The problem in the United States is much more the or- 
ganization of credit through the elasticity of lending 
power (carried out by using checks drawn on deposits 
which arise from loans) rather than the mere elasticity of 
notes — although the two are intimately connected to- 
gether. Hence, the wisdom of so separating the func- 
tions of issue and discount that, while their interde- 
pendence is clearly accepted, their distinct operation 
may be seen and their dangers and merits made entirely 
public. The silent education which will come from the 
separate publication of the issue and discount statements 
is not the least of the advantages of this provision. 

In Sections 16-20 it is intended to transfer the note- 
issuing function from the existing national banks to an 
issue department in the treasury board. 

It is assumed that bond-secured notes are so inelastic 
and undesirable that they will not be continued. In 
place of bonds, what security shall be provided? There 
are in the main the following alternatives: 

(1) Substitute the general assets of a bank for bonds and 
leave issues, as now, to the national banks. 

(2) Allow bonds, securities, etc., other than United States 



A PROPOSED BILL 191 

bonds, as security, as is provided by the Aldrich-Vreeland Act 
in effect through currency associations; and still leave issues 
to the individual national banks. 

(3) Take away the issues from the national banks and en- 
trust them to some agency acting for all the banks, and secure 
the notes by cash reserves, some United States bonds, and a 
flexible amount of selected commercial paper, sent in by Dis- 
trict Associations. 

(4) Retain existing national bank notes, but allow in addi- 
tion District Associations to issue notes based on deposit of 
bonds or commercial paper. 

(5) Substitute Government issues for national bank notes. 
These notes to be the promises to pay of the United States, 
but transferred by the Treasury to District Associations when 
needed by them in rediscounting for individual banks. 



(1) To allow a national bank to use any of its existing 
assets as a basis for note-issues implies a trustfulness in 
the character of the paper held in every bank, in any 
part of the country, which is not warranted. Such a 
plan would result in notes as varied in soundness as the 
managements of the different banks. Even if the notes 
were limited to a percentage of the bank's capital, this 
objection would still hold. To take away the security 
of United States bonds is to remove the very element 
which gives uniformity of value to the national bank 
notes in all parts of the country; and we thereby retro- 
grade to the faulty protection of most State bank notes 
from 1838 to 1864. 

Moreover, the permission to each national bank to 
issue notes based on its general assets, without close 
supervision over them, would lend itself to undue expan- 
sion, even if there were a restriction to some percentage 
of issues to capital. If such issues were safe, there should 
be no restriction on the amount of notes except the needs 
of the public (subject to contraction arising from im- 
mediate redemption in gold). So long as our present 



192 BANKING PROGRESS 

reserve system continues, the danger would exist that a 
surplus of bank-notes would remain in circulation, in- 
stead of being redeemed and retired, while a correspond- 
ing amount of legal tenders would be forced into bank 
reserves as hoards. Once reserve funds were thus in- 
creased, expansion would be almost certain to follow. 

Further, the State banks ought to be treated equally 
with national banks as regards issues as well as discounts. 
The withdrawal of the issues from individual banks, and 
their assumption by a single agency in behalf of all the 
banks, would be a protection against ill-advised action 
by any individual bank, and yet secure equality of treat- 
ment to State as well as to national banks. 

(2) The loose provisions of the Aldrich-Vreeland Act 
allow any kind of securities, such as railway or other 
bonds, and any kind of paper held by national banks, as 
protection to the emergency notes issued through cur- 
rency associations. But, in addition, the tax on these 
notes is so high that the rate charged to the borrower by 
a bank must be the result of panic conditions before they 
would possibly be asked for. With such a tax no resort 
is likely to be made to this act. Already the rate of in- 
terest (1912) has risen from 12 to 20 per cent and no ap- 
peal has been made to the law. 

(3) The currency problem is one not merely of the 
issue of notes; it is closely connected with the organiza- 
tion of credit. To get a loan, with a consequent deposit- 
account on which checks can be drawn, is as effective a 
means of paying debts, according to the business and 
banking habits of this country, as the actual passage of 
bank-notes. Either notes or checking accounts should be 
equally available to the legitimate borrower, according 
to his needs, and the habits of our people. The elas- 
ticity of the two must go together. From whatever 
angle we approach the subject of banking, it will always 



A PROPOSED BILL 193 

be found that soundness depends upon the kind of paper 
discounted. To secure soundness of discounts is the 
only real guaranty of safety to deposits. 

Hence, apart from carefully guarding the paper re- 
discounted by the district associations, we must face the 
question of the security of note-issues, which pass into the 
hands of innocent holders and whose safety must be 
beyond question. To avoid the danger of the varying 
character of notes, due to the varying soundness of assets 
in banks of all kinds, the obvious remedy is the selection 
of one agency which should issue the notes needed by all 
the banks. The security of the notes issued by one agency 
would be so under the limelight that anything but safety 
would be impossible. Simplicity of issues, understood 
by all, would be a great advantage. If the supervising 
body over the district associations be chosen as the 
issuing agency, little machinery and no capital would 
be needed. Moreover, the notes would be the obliga- 
tions of the combined district associations, but having a 
flexible margin of commercial paper which would make 
them entirely elastic, as well as entirely safe. Being re- 
deemable in gold at any district association, they could 
not circulate in amount beyond the currency needs of 
the public. The important consideration to be borne in 
mind is that the safety and redemption of the notes are 
placed on the banks, without any cost for reserves to the 
United States. This agency, under the close supervision 
of the government, secures all the advantages of govern- 
ment issues, without any expense or inelasticity. And 
if there is anything in the claim that the national banks 
gain a double profit by issuing notes based on United 
States bonds, it is clear that this is taken away, and all 
the profits, both of issue and discount (beyond 5 per 
cent on capital), go to the United States. 

The accounts of each district association would con- 



194 



BANKING PROGRESS 



tain the same items, and their combined figures reported 
to the treasury board would be published as totals every 
week. That is, the system of accounting at each district 
association would be identical; the combined weekly 
account would show the conditions for the whole coun- 
try, and the accounts of each district association would 
afford means of comparison and a knowledge of methods 
followed in each section. By way of illustration, certain 
arbitrary figures are introduced herewith in a combined 
account in order to show in general the working of a 
system in which the note-issues are separated from the 
discounting operations. 

Typical accounts: 



I. OPENING OF BANK 



Capital 


District Associations 
discount 


Dr. 
$100,000,000 


Cr. 


Cash reserves (national 
bank notes, lawful 
money) $100,000,000 


$100,000,000 


$100,000,000 


Treasury Board 
department of issue 







A PROPOSED BILL 

II. RECEIPT OF GOVERNMENT DEPOSITS 



195 



District Associations 
discount 




Dr. 

Capital $100,000,000 

Government deposits. . 100,000,000 


Cr. 

Cash (bank-notes 

lawful money) . . . 
Lawful money 


or 

...$100,000,000 
... 100,000,000 


$200,000,000 


$200,000,000 


Treasury Board 
department of issue 







III. RECEIPT OF 


BANK RESERVES 




District Associations 
discount 




Dr. 
Capital. $100,000,000 

Government deposits.. 100,000,000 
Bank reserves 400,000,000 


Cr. 

Cash (bank-notes 
lawful money) 

Lawful money 

Lawful money 




or 

..$100,000,000 
.. 100,000,000 
.. 400,000,000 


$600,000,000 


$600,000,000 


Treasury Board 
department of issue 







196 BANKING PROGRESS 

IV. READY FOR BUSINESS, DISCOUNTS TO BANKS 



District Associations 
discount 



Dr. 
Capital $100,000,000 

Government deposits. . 100,000,000 

Bank reserves 400,000,000 

Bank-deposits 200,000,000 

$800,000,000 



Cr. 
Loans $200,000,000 

Cash (bank-notes and 
lawful money) 600,000,000 



$800,000,000 



Treasury Board 
department of issue 



V. ISSUE OF NOTES ON DEPOSIT OF LAWFUL MONEY 
AT ISSUE DEPARTMENT (Section 17) 



Dr. 

Capital 

Government deposits. 
Bank reserves 


District Associations 

discount 


© © © o 
poo o 
"o © © © 
o o o o 
© © © © 
© © © © 
© © © © 
© © © © 


Cr. 
Loans $200,000,000 


Bank-deposits 


Cash (bank-notes and 

lawful money 400,000,000 

Treasury board notes.. 200,000,000 


Dr. 
Notes 


$800,000,000 


$800,000,000 


Treasury Board 
department of issue 


.$200,000,000 


Cr. 


Lawful money $200,000,000 

$200,000,000 


$200,000,000 



A PROPOSED BILL 



197 



VI. ASSUMPTION OF BONDS FOR. REDEMPTION OF 
NATIONAL BANK NOTES (Section 23) 



District Associations 
discount 


Dr. 
Capital $100,000,000 

National bank notes. . . 400,000,000 

Government deposits. . 100,000,000 

Bank reserves 400,000,000 

Bank-deposits 200,000,000 


Cr. 
Loans $200,000,000 

United States bonds . . . 400,000,000 
[320,000,000] 

Cash (lawful money)... [80,000,000] 
Treasury board notes . . 200,000,000 
Bank-notes and lawful 
money 400,000,000 


$1,200,000,000 


$1,200,000,000 


Treasury Board 
department of issue 


Dr. 

Notes $200,000,000 


Cr. 

United States bonds ... $ 80,000,000 

Lawful money 120,000,000 


$200,000,000 


$200,000,000 



The redemption of $400,000,000 of old national bank notes is assumed on 
the deposit of an equal amount of bonds. Then, later, $80,000,000 of these 
bonds are sent to the issue department in return for a like sum of lawful money. 



The separation of the issue of notes from all other 
branches of business and the publication of separate 
statements of everything pertaining to them is a power- 
ful safeguard against overissues and an important means 
of public education. Everybody, including the public, 
is thus kept fully informed regarding the aggregate vol- 
ume and the fluctuations of such issues, the amount and 
frequency of redemption, and the state of the gold re- 
serves; and such information will help to explain dis- 
count rates and other features of the business of the 



198 BANKING PROGRESS 

VII. ISSUE OF NOTES BASED ON COMMERCIAL PAPER 



District Associations 
discount 



Dr. 

Capital $100,000,000 

National bank notes. . . 400,000,000 

Government deposits.. 100,000,000 

Bank reserves 400,000,000 

Bank-deposits 200,000,000 



$1,200,000,000 



Cr. 



Loans $140,000,000 

United States bonds... 320,000,000 

Cash: 
Treasury board notes 60,000,000 
Treasury board notes 200,000,000 

Lawful money 80,000,000 

Bank-notes and law- 
ful money 400,000,000 



Treasury Board 
department of issue 



Dr. 

Notes $260,000,000 



$260,000,000 



Cr. 

United States bonds . 



$1,200,000,000 



$ 80,000,000 
60,000,000 



Commercial paper 

Lawful money of which 

$86,000,000 must be 

gold, i. e., \i of $260,- 

000,000 notes 120,000,000 



$260,000,000 



From the assets (loans) of the district associations $60,000,000 were taken 
to the issue department in exchange for an equal sum of treasury board notes. 
This final account would represent the system in complete operation. 

treasury board and the district associations in which 
the public will have interest. 



§ 9. To dispose of the bonds held by national banks 
to secure circulation the following sections were intro- 
duced: 

Sec. 23. National banks shall not emit any note issues 
beyond the amount outstanding on the day six months pre- 
ceding the date of the passage of this act. 

At any time within twelve months from the opening of said 
Treasury Board for business, each District Association may 



A PROPOSED BILL 199 

receive at par from any qualified National Bank within its dis- 
trict the United States bonds, now bearing 2% interest, held 
by the Treasury for the security of National Bank notes, and 
in return said District Association shall assume the redemp- 
tion of the national bank notes for which said bonds were 
pledged. 

Sec. 24. The Secretary of the Treasury is hereby empow- 
ered, upon the application of the Treasury Board, to exchange 
at par three per centum securities, as hereafter described, for 
the two per centum bonds of the United States bearing the cir- 
culation privilege, which have been obtained through the re- 
spective District Associations from duly qualified banks, in the 
following manner: One-half of the amount of bonds thus pre- 
sented for exchange at any one time shall be converted into 
three per centum bonds of the United States without the cir- 
culation privilege, payable permissably in five years and neces- 
sarily within twenty years from the date of issue; and one-half 
of the amount of bonds thus presented for exchange at any 
one time shall be converted into one-year notes of the United 
States, bearing three per centum interest, Provided, that the 
United States shall have the right to renew said one-year notes 
by due notice to said Treasury Board before maturity; or to 
pay them off in whole or in part at any time, provided further, 
that annual renewals shall not be made after twenty years. 

The Treasury Board shall be permitted at any time, with 
the consent of the Secretary of the Treasury, to offer any part 
of its holdings of United States bonds or one-year notes thus 
refunded at sale for gold; Provided, that the United States re- 
serves the right at any time to pay off any of such bonds or 
notes before maturity, or to purchase any of them at par for 
the trustees of the postal savings, or otherwise. 

Sec. 25. The additional interest charge incurred by the 
United States Government as a result of the refunding of the 
two per cents into three per cents shall be paid by the District 
Associations out of their gross receipts in such a manner and 
at such times, not less than once a year, as shall be determined 
by the Treasury Board with the consent of the Secretary of the 
Treasury. Each Association shall pay such a portion of the 
total amount as its capital and surplus bear to the aggregate 
capital and surplus of all the Associations. 



200 BANKING PROGRESS 

Sec. 26. All provisions of law requiring national banks to 
hold or to transfer and deliver to the Treasurer of the United 
States, bonds of the United States other than those required 
to secure outstanding circulating notes and Government deposits 
are hereby repealed. 

§ 10. Reserves are disposed of as follows: 

Sec. 27. The District Associations shall not pay interest on 
deposits. 

Sec. 28. Each qualifying bank must conform to the fol- 
lowing requirements as to reserves held against deposits: 

First: If located in a town having a population of 6000 in- 
habitants or less, and having a paid-in and unimpaired capital 
of not over $50,000, each qualifying bank shall deposit in lawful 
money with its District Association five per centum of its de- 
mand deposits of whatsoever kind. 

Second: If located in a town having a population of more 
than 6000 inhabitants, and having a paid-in and unimpaired 
capital of more than $50,000, each qualifying bank shall in 
its accounts distinguish between (1) bankers' balances, (2) in- 
dividual demand deposits, and (3) time deposits. 

Bankers' balances must be protected to the extent of 40 per 
centum, of which not less than 20 per centum shall be in law- 
ful money; and of said 20 per centum, not less than 8 per cen- 
tum must be deposited with its District Association; while 
the remainder of said 40 per centum (or 20 per centum) shall 
consist of commercial paper, as described in Section 8. 

Individual demand deposits must be protected to the extent 
of 30 per centum, of which not less than 15 per centum shall 
be in lawful money; and of said 15 per centum, not less than 8 
per centum must be deposited with its District Association, 
while the remainder of said 30 per centum (or 15 per cen- 
tum) shall consist of commercial paper, as described in Sec- 
tion 8. 

Time deposits payable in 30 days or less must be covered 
in the same manner as individual demand deposits; on other 
time deposits, 5 per centum reserves are to be kept. 

Credit deposits with its District Association shall be counted 
by any qualified member bank as a part of its required re- 
serves; but Treasury Board notes shall not be so counted. 



A PROPOSED BILL 201 

The question of banking reserves is much simplified if 
a separation is made between (1) reserves for note-issues 
and (2) reserves for deposits. In the national banking 
system reserves are kept solely for deposits, because the 
notes are protected, not by reserves, but by government 
bonds and a 5 per cent redemption fund (although this 
same redemption fund can be counted as part of the re- 
serves behind deposits). In the Monetary Commission 
Plan confusion is introduced by going back to our early 
defective banking system, in which one reserve was held 
against both notes and deposits. In any rational mod- 
ern system the protection for the notes should be pro- 
vided for quite independent of the rules for banking re- 
serves behind deposits. On this assumption nothing 
further need be said as to the reserves for redeeming notes. 

Deposits in commercial banks may arise either (1) 
from daily deposits of cash and checks by business firms, 
or (2) from a loan operation. The immediate and first 
result of a loan is the creation of a deposit-account to 
the credit of the borrower. Also, business concerns gen- 
erally expect loans from a bank about in proportion to 
the amount of their average deposits. Consequently, 
in most commercial banks the total item of loans does 
not vary much from the total item of deposits; if loans 
are much below deposits, it shows conservative lending. 
Since deposits are chiefly the outcome of loans, or of 
deposits of checks drawn on other credit accounts, re- 
serves are most closely connected with the borrowing 
or discounting at a bank. If loans are increased, there 
follows an increase of deposits, and hence an alteration 
in the percentage of reserves; and vice versa, if loans de- 
cline. Consequently, the question of reserves has to be 
considered chiefly in connection with the regional insti- 
tutions vested with the power to make discounts. 



202 BANKING PROGRESS 

Given a certain amount of demand-deposits, those in 
whose favor they stand may call for the use of their 
funds either (1) in the form of notes and cash, or (2) by 
drawing checks on their accounts. Which of these two 
forms will be resorted to depends upon the business 
habits and customs of the patrons of the bank. In large 
financial centres, and in most cities, large payments are 
made chiefly by checks ; in rural districts, where men are 
at a distance from banks, notes are often needed to com- 
plete a cash sale; but even here checks on banks are fast 
being introduced. The point to be kept in mind is that 
banks must provide whichever means of payment is de- 
manded by their customers. 

The pivotal question, however, is the relation of re- 
serves to the power of a bank to lend. If new loans are 
made, the demand-deposits are increased and the per- 
centage of reserves to deposits is lowered. Under pres- 
ent conditions, the borrower who wishes cash (e. g., to 
meet his pay-roll) will draw from lawful-money reserves, 
thus again lower the percentage of reserves, and cripple 
the immediate lending power of the banks. If, however, 
the district associations were empowered to exchange 
picked commercial paper for "treasury notes" at the 
offices of the treasury board, they could fill up their re- 
serves whenever a legitimate demand for discounts arose 
from individual banks; and the individual banks could 
draw these notes from their accounts with the district 
associations whenever the public needed cash. Thus 
the individual banks would be protected from drains on 
their lawful-money reserves by being able to pay out 
"treasury notes" whenever the owner of a deposit- 
account might choose to want cash (instead of drawing 
checks on his deposit-account). In effect, there are two 
restraints on overexpansion in regard to notes: (1) the 



A PROPOSED BILL 203 

surveillance over the commercial paper presented by 
individual banks to the district associations, accompanied 
by a rising scale of commissions, although the rate of 
discount is uniform in the district; and (2) another re- 
straint in passing paper from the district association to 
the treasury board for notes. The individual member 
banks should not be allowed to count "treasury notes" 
as reserves, but should be obliged to aid in founding our 
monetary system throughout the country broadly on 
gold. If "treasury notes" were to be counted in reserves, 
there would be a premium on holding them, getting more, 
and not sending them in for redemption when issues 
were not called for by the public. If individual banks 
could count deposits with district associations as re- 
serves, it would encourage deposits with other than cen- 
tral reserve city banks. It may not be logical to allow 
deposits to count as reserves, and not notes, but practical 
considerations should govern. If cash reserves are needed 
at home, individual banks can always get the notes re- 
deemed in gold. Thus the contraction, as well as the 
expansion, of "treasury notes" is obtained, which fulfils 
the true meaning of elasticity of the currency. 

Now we are in a position to discuss the idea that we 
must have a "centralization of reserves," in order to 
prevent the scattering of reserves (which is undoubtedly 
a great evil in times of alarm) . It is implied that all the 
cash reserves must be under one control, i. e., taken away 
from New York and placed in Washington. Why? In 
order that the reserves should be physically transferred 
from one place to another when needed? That is not 
credible. The whole question is one of mobilization of 
reserves (no matter where the exact spot of storage is) in 
order to make lending possible on picked commercial 
paper in time of stress. There is nothing to the reserve 



204 BANKING PROGRESS 

question except its effect on lending. The so-called cen- 
tralization of reserves is disposed of by any plan which 
enables discounts to be made in amounts as large as is 
consistent with safety and with the needs of legitimate 
borrowers. 

The only real fear those have who demand some "cen- 
tralization" is that otherwise no institution (i. e., no dis- 
trict association) will have enough resources, or be big 
enough, to meet emergency demands and secure respect 
in Europe. This objection can be met by having fewer 
district associations and having each one larger; instead 
of twenty, have no more than ten. In Chicago, for in- 
stance, in 1912, one large bank should have been able at 
once to get $10,000,000 added to its reserves by redis- 
counting good paper. The $10,000,000 credited as a de- 
posit to Bank X in Chicago as the result of the rediscount- 
ing would count as part of its reserve. That instantly 
touches its power to lend. Is this not the whole point at 
issue ? Why is there a need of any further " centralization 
of reserves"? A bank can draw "treasury notes" from 
its deposit-account with the district association, if cash is 
wanted in the Northwest, or elsewhere. That, of course, 
would lower its lately increased reserve, but the plan is 
made for just that purpose — to enable notes to be paid 
out in time to meet crop-movements. And the bank can 
get more reserves in the same way, if there is a real need. 
But it is to be remembered here that the bank might 
not, as now, draw notes from the district association as 
just suggested : by the system of transfers allowed in this 
plan, the given bank could transmit a credit to any other 
bank-account with any other district association; that 
deposit-credit would count as reserves to the given indi- 
vidual bank; and the lending power of that bank would 
be directly affected in the interest of its local borrowers. 



A PROPOSED BILL 205 

What more could be accomplished by so-called "centrali- 
zation of reserves"? Are not some persons caught more 
by a phrase than by the essential thing to be attained ? 

§11. Next we may present the matter of earnings. 

Sec. 35. The earnings of each District Association shall be 
disposed of in the following manner: 

After the payment of all expenses and the reduction of losses, if 
there be any, the semi-annual earnings shall be distributed among 
the qualifying banks in proportion to the number of shares 
owned by each, except that earnings in excess of four per cent 
per annum of the total paid-up capital stock shall be distributed 
as follows: One-half of the excess shall be distributed among 
the qualifying banks and one-half be transferred to an account 
of the Government of the United States on the books of the 
Treasury Board, provided that the total amount of said surplus 
paid to the qualifying banks shall not exceed one per cent of 
the total paid-up capital stock, it being the intent of this act 
that all earnings in excess of five per cent of the total paid-up 
capital stock shall be credited to the account of the Govern- 
ment of the United States on the books of the Treasury 
Board. 

After each dividend has been declared, all additional earn- 
ings shall be transferred to the account of the Government of 
the United States on the books of said Treasury Board, and 
shall be disposed of by said Treasury Board as follows, and in 
the following order of precedence: 

(a) A sum equal to one-fourth of one per cent of the capital 
stock of each District Association shall be set apart annually 
for eight years, to form a contingent fund to meet any possible 
losses. In case of liquidation, this fund shall be credited to 
the account of the United States Treasury. 

(6) A sum equal to one per cent of the capital stock shall be 
assigned annually to a surplus fund until such fund shall amount 
to 20 per cent of said capital. 

(c) Of United States notes held in special reserve by the 
Department of Issue, as hereinbefore provided, a portion equal 
to the balance on the account of the Government of the United 



206 BANKING PROGRESS 

States shall be returned to the Secretary of the Treasury for 
cancellation and destruction, the Government's account being 
debited with the amount thus returned; Provided that the max- 
imum amount thus returned shall not exceed the amount of 
the total issue of such notes in excess of the $150,000,000 gold 
reserve held by the Secretary of the Treasury for their redemp- 
tion. After all the United States notes in excess of said $150,- 
000,000 gold reserve shall have been cancelled and destroyed 
in this manner, all additional holdings of such notes by the 
District Association and all such notes in any manner coming 
into the possession of the District Associations in the future 
shall be exchanged for gold at the Treasury of the United States, 
and the notes so exchanged shall be cancelled and destroyed; 
and all such notes thereafter coming in any manner into the 
possession of the Government of the United States shall in 
like manner be redeemed, cancelled and destroyed. 

(d) Any such earnings as are not disposed of in the manner 
indicated in paragraphs (a), (b), and (c) shall be applied to the 
purchase at par from the District Associations or the Treasury 
Board of holdings of the three per cent refunded bonds here- 
inbefore described. 

(e) After all such purposes mentioned in this section shall 
have been fulfilled, any surplus earnings of said District Asso- 
ciation shall be paid into the account of the United States 
Treasury. 

The provisions of Section 35 are based on two prin- 
ciples: (1) that the institutions created by this act should 
not be influenced in their operations by the desire, or 
the need, of earning large dividends for their stockhold- 
ers; and (2) that any profits accruing to the United States 
Government from their operations should be used in the 
improvement of our currency and in the payment of the 
national debt. 

What is needed is not an additional source of revenue 
for our banks and trust companies, but means for their 
more complete functioning, to the end that financial 
crises may be avoided and the agricultural, industrial, 



A PROPOSED BILL 207 

and commercial interests of the country be better served. 
The treasury board and the district associations should 
be guided solely by considerations of the latter kind, and 
to this end this section limits the dividends that can be 
paid to stockholders to 5 per cent of their holdings of 
stock. It is believed that dividends of at least this 
amount will be earned without special effort on the part 
of the associations, and that such dividends will consti- 
tute sufficient financial remuneration to the banks and 
trust companies that join the association, their chief 
remuneration being the rediscount and other advantages 
which membership will bring. 

It is more than likely that actual earnings will be 
greatly in excess of expenses plus 5 per cent of the cap- 
ital stock. In this case means will be provided for rid- 
ding our currency of the United States notes which take 
the place in our currency of an equivalent amount of 
gold and impose upon the Treasury the dangerous obliga- 
tion of maintaining a gold reserve. The requirement 
according to the provisions of this act will not occasion 
even a temporary contraction of the volume of the cur- 
rency, since treasury notes will take their place as fast 
as they are withdrawn from circulation, and gold will 
take their place in the reserves of the district association 
when they are cancelled and retired. Neither will their 
retirement occasion any expense to the government; on 
the contrary, by these means a portion of the public 
debt will be paid off by profits derived from private busi- 
ness agencies. 

After the retirement of the United States notes and the 
accumulation of adequate contingent and surplus funds, 
the use of surplus profits in the purchase of 3 per cents 
from the district associations is desirable, since the sub- 
stitution of commercial paper and gold for bonds as cover- 



208 BANKING PROGRESS 

ing for the treasury notes should be accomplished at the 
earliest possible moment, and while such substitution 
can be accomplished by the sale of the bonds on the open 
market, such sales may not happen to be in the inter- 
ests of the Treasury at the time they ought to be made 
in the interests of the district associations and the cur- 
rency. 

This section must be considered in connection with 
Sections 17 and 18, which provide for the gradual retire- 
ment of the greenbacks, and the national bank notes. 
Under the operation of its provisions, these forms of cur- 
rency would gradually accumulate in the reserves of the 
treasury board and notes of the board would take their 
place in the circulation of the country. 

Sections 29-34 on investments are similar to Sections 
32-36 and 38 of the National Monetary Commission 
Plan, 1 and need not be reproduced here. In Section 30 
authority was granted to district associations to invest in 
the short-time paper of foreign governments. Such in- 
vestments would have the special advantage of putting 
the district associations in a position to draw gold from 
abroad, either through collection at maturity or redis- 
counts on foreign markets. 

§ 12. The old problem of correcting the evils of the 
independent treasury is taken up as follows: 

Sec. 36. The Government of the United States shall upon 
the organization of the Treasury Board deposit its general 
funds in any of said District Associations, and thereafter all 
receipts of the Government, exclusive of trust funds, shall be 
deposited with said District Associations, and all disburse- 
ments by the Government shall be made through said District 
Associations. 

1 See Appendix II. 



A PROPOSED BILL 209 

The elimination of the disturbances on the money 
market occasioned by the operations of our independent 
treasury system is one of the chief advantages to be at- 
tained by the establishment of the treasury board and 
district associations. The present section provides for 
the use of the district associations by the government as 
a place of deposit for all its cash except the trust funds. 

The retention by the Treasury of these latter funds, 
consisting of the gold held for the redemption of the gold 
certificates, the $150,000,000 gold reserve held against 
the United States notes and the silver dollars held for 
the redemption of the silver certificates, is a matter of 
indifference to the money market, the volume of the cur- 
rency not being in any way affected by them and the 
redemption operations based upon them. It is the 
locking up of funds in the Treasury when receipts exceed 
expenditures and their deposit and withdrawals from 
the depository banks at the option of the secretary of 
the treasury that causes the trouble which it is proposed 
to remove by making the district associations the deposi- 
tories and disbursing agents of the government. 

§ 13. Section 37 of this bill on foreign banking was 
the same as Section 57 of the plan of the National Mon- 
etary Commission, and need not be reprinted. (See Ap- 
pendix II.) 

This section has nothing to do directly with the dis- 
trict associations and might easily be included in a sepa- 
rate act. It is, however, not inappropriate to include it, 
since the district associations, by creating a market for 
commercial paper, will greatly increase our facilities for 
transacting foreign business, and thus make desirable 
the creation of the kind of institution for foreign bank- 
ing here provided for. 



210 BANKING PROGRESS 

The provisions of this section give the district associa- 
tions full authority to replenish their gold reserves by 
negotiations on foreign markets if necessary. Such au- 
thority is necessary in the interests of safety and their 
proper management at all times. 

To what extent the district associations would find it 
necessary or desirable to open offices in foreign countries 
is uncertain, but foreign connections in the form of ac- 
counts with foreign banks and agencies would be indis- 
pensable. 

Authority to buy and sell foreign bills is justified on 
the same grounds as investments in the short-time paper 
of foreign governments. A portfolio of foreign bills 
would constitute the best reserve protection the district 
associations could have, since such bills could ordinarily 
be turned into gold at any time. 

§ 14. Provision as follows was made for reports and 
examinations : 

Sec. 38. Monthly balance sheets in the form prescribed by 
the Treasury Board, guaranteed as to correctness by their re- 
spective Boards of Directors, shall be supplied to the District 
Associations by all banks whose names appear on the paper 
offered for discount. 

Balance sheets of firms and corporations whose paper is 
offered for discount, in the form prescribed by the Treasury 
Board, shall also on request of the District Association be fur- 
nished by the bank offering such paper for discount, and such 
balance sheets shall represent no asset at more than its actual 
value and no liability at less than its true amount. 

The Treasury Board shall make a report showing the totals 
of the principal items of its balance sheet and of all the Dis- 
trict Associations once a week. These reports shall be made 
public. In addition, full reports shall be made to the Comp- 
troller of the Currency by said Treasury Board, coincident with 
the five reports called for each year from the national banks. 



A PROPOSED BILL 211 

All reports of national bank examiners in regard to the con- 
dition of banks shall hereafter be made in duplicate and one 
copy filed at the office of the Treasury Board for the confiden- 
tial use of its executive officers and District Associations. 

The Manager of each District Association may call for re- 
ports of State bank examiners applying to State banks quali- 
fying for rediscounts, and in case such reports are not for any 
reason supplied, the District Association shall have the power 
to make examination of such banks through its own officers. 

The Secretary of the Treasury shall annually appoint a com- 
mittee of five persons, at least three of whom shall be expert 
accountants, to make from time to time a careful examination 
of the conditions and business of the Treasury Board and the 
District Associations and to make at least once a year a public 
statement of the results of such examination. 

The Treasury Board shall also annually appoint from among 
their number a committee of three persons to make at least 
once in three months a careful examination into the condition 
and business of the Board. This committee shall report to the 
Treasury Board. 

The balance-sheet reports required from qualifying 
banks and from corporations, firms and individuals whose 
names appear on the paper offered for discount are im- 
portant, not only because they will supply the data 
needed in the determination of the quality of such paper 
and the character and methods of business of the insti- 
tutions presenting it, but because of the influence it will 
have on the conduct of business by the promotion of 
balance-sheet accounting. To compel business concerns 
frequently to prepare accurate balance-sheets will go far 
toward promoting sound and eliminating unsound opera- 
tions. 

The affairs of the treasury board and district associa- 
tions must be given wide publicity, because its operations 
will constitute the money-market barometer of the coun- 
try, Hence the requirement of the publication of weekly 



212 BANKING PROGRESS 

balance-sheets. Every precaution should also be taken 
that their affairs are conducted in a proper manner. 
Hence the requirement of reports to the comptroller of 
the currency and of examinations by expert accountants 
and financiers and by committees of the directors. 

§ 15. The next sections deal with the serious diffi- 
culties of clearings and collections: 

Sec. 39. Whenever a District Association shall have re- 
ceived for collection checks and drafts drawn on institutions 
outside its own district, it shall send to each of the other Dis- 
trict Associations those drawn upon institutions within the dis- 
trict of said Association with the aggregate amount of the 
checks and drafts so sent. It shall credit to the account of 
each Association the checks and drafts in like manner sent in 
for collection. At the close of each day's business each Dis- 
trict Association shall send to the Treasury Board hereinafter 
described a statement of the amounts thus debited and credited, 
together with the balances due the other Associations or due 
by them to it, and in case the net balance is adverse, it shall 
accompany said statement with a check to the amount of said 
adverse balance drawn against its account with the Treasury 
Board. Each District Association shall keep with the Treasury 
Board a balance sufficient to cover such checks. The Treasury 
Board shall each day credit to the accounts of the District 
Associations having favorable balances the proceeds of the 
checks thus received. 

The Pujo Committee raised a question as to great 
sums earned by city banks in collections of checks. The 
provisions of this bill cover all that matter, and provide 
for collections of checks with an advantage to all the 
banks, large or small. These advantages arise from the 
creation of district associations, superimposed on exist- 
ing clearing-houses, as already described. The district 
associations will assume not only the discounting func- 



A PROPOSED BILL 213 

tions of the clearing-houses (accompanied with the in- 
hibition of clearing-house certificates), but also introduce 
an economy in the present system of collections. 

This bill allows, of course, the system of transfers from 
one account to another on the books of any district asso- 
ciation, which was contained in the plan of the Monetary 
Commission. This is, in effect, the well-known method 
of giroverkehr by the Reichsbank. The clearing of coun- 
try items is not provided for by the German system; for 
checks drawn on deposits are little used in Germany. 
This bill goes further: it provides for needs created by 
the customs of our own country. It is made the duty 
of the district associations to further in every possible 
way the clearing of checks between banks in all parts 
of the country. The method is simple. 

Nothing in this bill interferes with the offsetting of 
checks by the 137 clearing-houses within their respective 
cities. In each city, however, banks would sort checks 
into (1) city, or (2) outside items. The former would 
go to the city clearing-house, as now. The latter would 
go to the district association, and the course of proceed- 
ings would be as follows: Bank X, in Chicago, might 
present to its district association (in Chicago) items 
composed of checks on banks outside of Chicago, to, say, 
$1,000,000. Immediately Bank X, a qualified bank, 
having an account at the district association, would be 
credited with the $1,000,000, without the expense or 
delay of collecting checks all over the country (varying 
from two to ten days), and without the loss of interest 
thereby involved. These items are at once sorted by the 
Chicago district association into two classes: (1) those on 
banks within the territory of the Chicago district asso- 
ciation, and (2) those on banks in other district associa- 
tions. For (1), the checks would be debited to the ac- 



214 BANKING PROGRESS 

counts of qualified banks on the books of the Chicago 
district association (since only checks of qualified banks 
would be handled). For (2) the checks would be sorted 
according to the district association in which the banks 
are situated, and each package sent immediately to its 
respective district association. On receipt by each dis- 
trict association the checks are charged to the accounts 
of the qualified banks in each district association. Since 
each qualified bank's account would be thus credited 
and debited on the books of its respective district associa- 
tion, only balances need be paid; and these balances 
would be paid by checks drawn on the district associa- 
tion, thus avoiding all needless movement of cash be- 
tween both district associations and individual banks. 
The economy of this process would be very important. 
The expense of recording each item for verifying its prog- 
ress would be considerable, and not to be overlooked. 
The present wasteful shipments of actual cash from large 
cities to distant parts of the country would cease. The 
cost of collections, about which so much complaint has 
been made, would be reduced. The large banks would 
have a cash credit immediately on deposit of outside 
items. Such a provision for the extension of the clear- 
ing-house function throughout the whole country (in- 
stead of being confined within any one city), through the 
district associations, directly under governmental super- 
vision, would tend to remove all existing clearing-houses, 
which are unincorporated and voluntary associations. 
Thus whatever problems — if any — were raised by the 
Pujo Committee would be fully met by the provisions of 
this bill which puts under lawful control both the dis- 
counting and offsetting functions of existing clearing- 
houses. In this case, the law could be said to have over- 
taken the voluntary and extralegal operations of trade 



A PROPOSED BILL 215 

and banking, the supervision of which is undertaken in 
the interest of equality to all, big or little. 

It is to be observed, finally, that these provisions, for 
assuming and legalizing all the functions of clearing- 
houses — especially the inhibition of clearing-house cer- 
tificates in time of panic — form the strongest possible 
reasons why all banks should qualify with their respec- 
tive district associations. They could not afford to take 
the risk of staying out; while, if they come in, they 
gain positive advantages in collections as well as in re- 
serves, and full opportunity for rediscounts without fear 
or favor. 

It may not be desirable to force this system of collec- 
tions and clearings at the outset; but to make it possible 
under the act and permit it to develop by a natural and 
gradual growth. 



CHAPTER X 
THE FEDERAL RESERVE ACT 

§ 1. Out of all the efforts for reform in the past gen- 
eration, and from the various proposals of different 
minds, there was actually passed in the Federal Reserve 
Act of 1913 the most comprehensive monetary and bank- 
ing law ever placed on our statute-books in the whole 
history of the nation. It marks the culmination of our 
banking progress. Toward this result many events have 
contributed. It is an interesting story with a happy 
ending. 

In order to be able to test the new legislation, 1 it will 
be interesting to summarize here the defects in our bank- 
ing and currency system which were generally accepted 
at the beginning of the recent campaign (1910-1913) : an 
inelastic bank-note circulation; an even more dangerously 
inelastic credit system; ineffective use of a large supply 
of gold; a scattering of reserves and lack of co-operative 
action by banks in times of stress; a rigid reserve system 
which induced panics; State banks and trust companies 
doing a commercial business but in different systems; 
an independent treasury divorced from the money mar- 
ket which imperilled bank reserves in times of difficulty; 
the drift of idle funds to the call-loan market where they 
fed stock speculation; and the want of American banking 
facilities in other countries to aid our foreign trade. It 

1 The original text of the act is given in the First Annual Report of the Fed- 
eral Reserve Board, December 31, 1914, pp. 25-44, as well as in many other 
places. In amended form it can be obtained by any one on application to the 
Federal Reserve Board, Treasury Department, Washington, D. C. 

216 



THE FEDERAL RESERVE ACT 217 

will be fitting to watch as we go on whether these de- 
mands, which were formulated before the new law was 
even drawn up, have been effectively covered. 

We may then proceed to an examination of the act of 
December 23, 1913. In order to secure clearness it may 
be best to discuss its provisions under some general heads, 
and under each head to include the history of the various 
proposals, as follows: 

(1) Control and Organization 

(2) The Federal Reserve Banks 
(8) The Note-Issues 

(4) Disposal of the 2 Per Cent Bonds 

(5) Reserves 

(6) The Organization of Credit 

(7) Clearings 

(8) A Discount Market 

(9) Foreign Banking 

§ 2. Around the question of organization and con- 
trol centred the main antagonism to the plan 1 of the 
National Monetary Commission, which proposed a na- 
tional reserve association as the means for centralizing 
reserves and thus preventing the admitted evil of the 
scattering of reserves existent under the old system. In 
this scheme an elaborate organization was built up, be- 
ginning with local associations of banks which elected 
directors for district institutions of which there were to 
be fifteen in the whole Union; these fifteen directorates 
were to elect a central governing body of forty-five, with 
an executive committee of nine, in power over the national 
reserve association, of which the fifteen institutions were 
to be branches. It is to be observed that the directors of 
the central body were to be chosen by the representatives 

1 See Appendix II for the plan. 



218 BANKING PROGRESS 

of the banks. Such an institution was not, in the usual 
acceptance of the term, a central bank, because it would 
do no business with the general public. Nevertheless, 
having one central directing body elected by the banks, 
opposition was raised against it on the ground that effec- 
tive control over it might be obtained by ambitious finan- 
cial groups. This opposition appeared under the so- 
called "fear of Wall Street." 1 

In the original Glass Bill, proposed by the House com- 
mittee, and given out unofficially June 17, 1913, there 
was proposed an entirely different system of organiza- 
tion and control. Instead of a national reserve associa- 
tion with fifteen branches, there was offered a decentral- 
ized organization of separate, incorporated, regional Re- 
serve Banks, in as many districts, supervised by a Federal 
Reserve Board, having no capital and no banking func- 
tions. 2 Immediately attention was focussed upon the 
composition and powers of the Federal Reserve Board, 
since it was assumed that this board would have direc- 
tion over the general banking operations of all the banks 
in the country, State or national, which might enter the 
new system. As to its composition, the original Glass Bill 
gave equal representation on the Federal Reserve Board 
to the lending bankers, the borrowing business public, 
and the government. A board of nine members was to 

1 In Congress it was emphatically stated that, irrespective of the merits of a 
central bank, it could not be proposed by Democrats, because it was forbidden by 
the Baltimore platform. Cf. p. 146. It is difficult to reconcile this position with 
that taken in favor of abolishing all preferences to American coasting-vessels 
going through the Panama Canal, which was in direct opposition to the platform 
of the Democratic party. The truth probably is that political advantage was 
gained by opposing a central bank. In addition, it may well be that regional 
banks were better suited to our conditions. 

2 Mr. Mann, the Republican leader in the House, said: "So far as we have 
been able to learn, the bill will be in the main pieces stolen from the Aldrich 
Monetary Commission Report, with a few radical provisions taken from the 
Bryan platform mixed in. It will be a jumble of discordant ideas. " (June 23, 
19l3.) 



THE FEDERAL RESERVE ACT 219 

be composed of (1) the secretary of the treasury, the 
secretary of agriculture, and the comptroller of the cur- 
rency, ex officio; (2) three to be chosen by the President 
of the United States, of whom one would be designated 
as governor, etc.; and (3) three, presumably bankers, to 
be chosen by the Federal Reserve Banks. 

When the bill prepared by the House committee 
came to be passed on by Democratic leaders, before it 
was adopted as an administration measure, the issue of 
control became prominent and drew great discussion. 
The administration demanded governmental control over 
the banking system, urging that bankers per se were the 
ones to be supervised, and, therefore, should not control 
the Federal Reserve Board (any more than railway men 
should control the Interstate Commerce Commission). 
Accordingly, the Glass Bill, before being presented to the 
Democratic caucus of the House, was modified by chang- 
ing the number of the board from nine to seven, of whom 
the two cabinet officers and the comptroller were to be 
ex officio members, and four others were to be appointed 
by the President, of whom one (later changed to two) 
should be experienced in banking. The original bill pro- 
vided only that the governor of the board could be re- 
moved by the President on a statement of the reasons; 
while in the changed bill the President was given power 
of removal for cause over the four members appointed 
by him for a term of ten years. On June 23, 1913, Presi- 
dent Wilson read in person to the extra session of Con- 
gress his currency message, in which he said: 

The control of the system of banking and of issue which our 
new laws are to set up must be public, not private, must be 
vested in the government itself, so that the banks may be the 
instruments, not the masters, of business and of individual 
enterprise and initiative. 



220 BANKING PROGRESS 

As opposed to this view the bankers held that they 
were obliged by the bill to enter the system, or lose their 
charters as national banks; that a portion of their capital 
was "commandeered" for the stock of the new organiza- 
tions, over which they were refused any control; that 
such a forced contribution without representation was 
practical confiscation; that such an invasion of the gov- 
ernment into the realm of private ownership was "social- 
istic"; and that, in the analogy of the Interstate Commis- 
sion, the commission supervises, but does not pretend 
actually to operate, the railways, while the Federal Re- 
serve Board is given direct control over banking opera- 
tions. The American Bankers' Association, at Boston, 
October 8, 1913, opposed the compulsory contribution 
of capital without representation on the board as follows : 

In return for the capital thus appropriated the banks receive 
a certificate, which cannot be sold, assigned, or hypothecated, 
over which none of the usual rights of property can be exer- 
cised. [National] banks are obliged to make this subscription, 
or be dissolved. Charters have ever been regarded in the 
nature of a contract, and it is doubtful if, under our Constitu- 
tion, Congress can take away the charter of a bank in this 
summary manner, not because the terms of the charter have 
been violated by the banks, but because the bank management 
might refuse to make a coerced investment such as the pend- 
ing measure provides. 

... If the government can appropriate one-tenth of a bank's 
capital in the manner provided by this bill this year, it 
may appropriate one-tenth the next year, and so on until 
the capital is all transferred to the government bank. If it 
can fix the compensation at 5 per cent this year, it may make 
it 4 per cent next year, and 3 per cent, % per cent, 1 per cent — 
a very simple and easy process whereby the entire capital of the 
banks may be transferred to the government. 

... This proposition of the government to take the banks* 
capital in the manner provided, carried to the extreme, would 



THE FEDERAL RESERVE ACT 221 

easily accomplish, so far as the national banks are concerned, 
this contention on the part of the Socialists. For those who do 
not believe in Socialism it is very hard to accept and ratify 
this proposed action on the part of the government. 

To the bankers political control by appointees of the 
President, without banking experience, meant incom- 
petent management. Consequently, they urged that 
three members of the board should be elected by the 
directors of the Federal Reserve Banks. 

Thus was the issue joined between government super- 
vision and banking control. It is now obvious that the 
issue hinged on the powers granted to the Federal Reserve 
Board. If actual banking operations are carried on, 
not by the Reserve Board but by the directors of the re- 
spective Reserve Banks, a majority of whose directors 
are chosen by the member banks, the question at issue 
practically disappears. What, then, are these powers? 

In Sec. 11 are enumerated the powers of the Federal 
Reserve Board: 

(a) To examine, and require weekly statements of, reserve 
and member banks. 

(6) To permit, or by a vote of five members to require, one 
Federal Reserve Bank to rediscount for another, and to fix the 
rate of discount charged in such a case. 

(c) To suspend reserve requirements for not more than thirty 
days, provided a tax is imposed on Reserve Banks should re- 
serves fall below a certain percentage. 

(d) To supervise the issue and retirement of Federal Reserve 
notes. 

(e) To add to, or reclassify, existing reserve or central re- 
serve cities. 

(/) To remove for cause any officer or director of any Reserve 
Bank. 

(g) To require Reserve Banks to write off worthless assets. 
(h) To suspend any Reserve Bank for violations of this act. 



222 BANKING PROGRESS 

(i) To safeguard all collateral, notes, etc., deposited with 
its agents; and to make all rules necessary to enable the Board 
to perform the duties, functions, or services of this act. 

(j) To exercise general supervision over Reserve Banks. 

(k) To permit national banks to act as trustee, executor, 
etc., and establish rules therefor. 

(0 To employ experts, assistants, clerks, etc., and fix their 
salaries and fees. 

Besides the grant of these specific powers, additional 
powers 1 were granted in other sections throughout the 
act as follows: 

1. To readjust Federal Reserve districts (sec. 2). 

2. To regulate the establishment of branch banks within 
the respective Federal Reserve districts, and appoint three 
directors for each branch (sec. 3). 

3. To designate three members (Class C) for each Federal 
Reserve Bank, one to be chairman of the board and known 
as the "Federal Reserve Agent''; and to secure impartial 
treatment to each member bank (sec. 4), 

4. To call at discretion the unpaid half of capital stock; 
to determine the amounts returned to a bank withdrawing 
from membership (sec. 5); and to pass on the amount of any 
reduction of capital (sec. 28). 

5. To pass on applications for membership from state banks, 
and to establish by-laws therefor; to prescribe rules enforcing 
requirements of this act (sec. 9). 

6. To require a member bank to surrender its stock, if it 
fails to comply with the law or rules of the Board (sec. 9). 

7. To levy on the Reserve Banks a semi-annual assessment 
to cover the expenses of the Board (sec. 10). 

8. To have general supervision over the Bureau of the Comp- 
troller of the Currency (sec. 10). 

9. To make an annual report to the Speaker of the House of 
Representatives (sec. 10). 

10. To approve salaries and allowances granted to members 

1 Cf. Report of House Committee on Banking and Currency, September 9, 1913, 
No. 69, Sixty-third Congress, 1st session, pp. 46-47. 



THE FEDERAL RESERVE ACT 223 

of Advisory Council; and to call meetings of said Council (sec. 
12). 

11. To define the character of the paper eligible for redis- 
count by Reserve Banks; and to regulate discounts by said 
banks of bills receivable, bills of exchange, and acceptances 
(sec. 13). 

12. To fix the percentage to the capital of a Reserve Bank 
which limits the discounts of agricultural paper having a ma- 
turity of not over six months (sec. 13). 

13. To establish rules for dealings in cable transfers, accep- 
tances, and bills of exchange, or in securities of the United States, 
or subdivisions thereof, by Reserve Banks (sec. 14). 

14. To review rates of discount charged by Reserve Banks 
(sec. 14). 

15. To pass on applications of Reserve Banks wishing to 
engage in foreign operations (sec. 14 (e)). 

16. To issue at discretion Federal Reserve notes to Reserve 
Banks on deposit of an equal amount of collateral security; 
to call for additional security therefor; to assign a distinctive 
letter and serial number for notes issued by the respective 
Reserve Banks; to require each Reserve Bank to maintain 
at the United States Treasury a gold reserve (not less than 5 
per cent) for its own notes; to grant or to reject any applica- 
tion for notes; to establish the rate of interest to be paid for 
such notes; to make rules allowing substitutions of collateral 
behind the notes; and to charge Reserve Banks with all ex- 
penses due to printing, issue, and retirement of such notes 
(sec. 16). 

17. To fix charges for checks cleared through Reserve Banks 
and for transfer of funds among said banks (sec. 16). 

18. To establish at its discretion a Clearing House for Re- 
serve Banks, or one for member banks (sec. 16). 

19. To require Reserve Banks to purchase United States 
bonds when member banks give them up to withdraw circula- 
tion, according to a given allotment (sec. 18). 

20. To grant approval of refunding of 2 per cents into 3 
per cents by the Secretary of the Treasury and Reserve Banks 
(sec. 18). . 

21. To permit a non-member to obtain discounts from a 
Reserve Bank through a member bank; to allow the reserve 



224 BANKING PROGRESS 

of a member bank with its Reserve Bank to be drawn upon 
under penalties; and to allow national banks in Alaska and 
outside the continental United States (except the Philippines) 
to join a reserve district (sec. 19). 

22. To examine member banks; to accept in some cases 
examinations of member banks by state authorities; to fix 
salaries of examiners (instead of the present fee system); to 
permit special examinations; to demand information from a 
Reserve Bank at any time regarding a member bank; to order 
an examination of each Reserve Bank at least once a year 
(sec. 21). 

23. To add to the list of cities in which national banks are 
not permitted to loan on real estate (sec. 24). 

24. To approve or reject applications of national banks to 
establish foreign branches, and to order examinations of said 
branches (sec. 25). 

25. To force a national bank to cease to act as a reserve agent, 
if it did not enter the system within 60 days after the act was 
passed (sec. 2). 

A study of these powers of the board shows that they 
are mainly supervisory or administrative after the gen- 
eral example of the powers of the comptroller of the cur- 
rency over national banks. In a few respects, however, 
it may be said that the board has more than supervisory 
powers. 

In Sec. 11 (b) and (c) the board is given power to re- 
quire one Reserve Bank to discount for another, and to 
suspend reserve requirements (for member banks as well 
as Reserve Banks) for not more than thirty days. This 
latter power, to be sure, has been exercised in effect by 
the comptroller's discretion in not closing a bank whose 
reserves were below the legal limit. In making general 
definitions regarding eligible paper for discount (Sec. 13), 
the action of the board is still in the main supervisory. 
Moreover, it has only powers of review, not initiative, 
over the rate of discount set by the respective Reserve 



THE FEDERAL RESERVE ACT 225 

Banks (Sec. 14). Also, the board may reject applica- 
tions from Reserve Banks for notes, but probably this 
authority is only to be exercised in order to restrict un- 
healthy expansion, or because the collateral was unde- 
sirable, and the like. In regard to establishing a system 
of clearings (Sec. 16), however, the board has powers of 
initiative which are certainly more than merely super- 
visory, touching not only the earnings, but the existing 
methods of business of member banks. Also quite as 
important as any is the power to suspend any officer or 
director of any Reserve Bank (Sec. 11 (/)), which means 
obviously any director elected by the banks as well as 
its own appointees. Yet it is to be observed that in no ■ 
case is the board empowered to conduct strictly banking 
operations of discount and deposit. 

On the other hand, as distinctly opposed to the Federal 
Reserve Board, stand the Federal Reserve Banks, to 
whom are given all strictly banking functions of discount, 
deposit, and — in a practical sense — issue. While the 
bill was in the hands of the Senate committee an attempt 
was made, and supported by the Republican minority, 
to give direct banking powers to the Reserve Board, thus 
creating a type of central bank. Fortunately, this pro- 
posal failed. Consequently, the success of the new system 
must depend for its essential banking operations on the 
managements of the respective Reserve Banks. 

As regards the general question of control, it is to be 
noted that there is a distinction to be made between 
governmental and political control. There may be gov- 
ernmental supervision and direction through the Reserve 
Board which is not political, provided the board is not 
governed by political motives in its action. Appoint- 
ment of members of the board by the President should 
not mean political management any more than in the 



226 BANKING PROGRESS 

case of the supervision exercised by the comptroller of 
the currency over national banks in the past; or any 
more than presidential appointment of judges means 
political decisions on the law. More than this, it is to 
be kept in mind that the control of discounts and de- 
posits, the primary functions in a banking system, is 
placed in the hands of the boards of the respective Re- 
serve Banks, the majority of whom are elected by mem- 
ber banks, and who should be men of practical banking 
experience. Thus, while there is governmental super- 
vision by the Reserve Board, as above described, all 
questions of discounts and use of deposits, in the daily 
round of business, are left to technical bankers. 

As to the possibility of changing the political character 
of the Reserve Board, let us assume that President Wilson 
were succeeded by a Republican on March 4, 1917. The 
board was being appointed in (say) April, 1914. Then 
the term of the member appointed for four years would 
expire in April, 1918; and of the one for six years, in 
April, 1920. Hence both of these positions, in addition 
to the appointment of the secretary of the treasury, might 
be filled by a new President. The term of office of the 
comptroller of the currency, appointed in 1914, being 
five years, his successor would be named by a new Presi- 
dent. Thus a majority of the board (four out of seven) 
could be reconstituted in the term of the next President. 

The co-ordinating influence of a supervisory board will 
go far to remedy the scattering of reserves formerly so 
great an evil; to establish continuity of policy; to gain 
co-operation between all the banks represented in the 
Reserve Banks; to check trouble in one district before 
it has extended to another; and, without the dreaded 
centralization, to have federation with local government 
in each district. Already concentration, without legal 



THE FEDERAL RESERVE ACT 227 

regulation, had appeared, but it had not prevented scat- 
tering of reserves, nor an individualistic condition of 
banking (very far from the common control that had 
been so much feared). The legal creation of a central 
body which could have been captured and used would 
have been a very much more dangerous thing. Regional 
banks, each sovereign in its own district as regards dis- 
counts, have probably removed this danger forever. 
Moreover, the Federal Advisory Council, one member 
chosen respectively by each Reserve Bank, gives the 
board a nexus with conditions in all parts of the Union, 
and by the publicity of its opinions should exercise an 
influence proportionate to the soundness of its judgment. 

§ 3. The legislative struggles gathered mainly about 
this question of central control. The nice point in the 
result was the right adjustment of the powers of the 
over-board as compared with those of the Reserve Banks. 
►Here was the need of high legislative skill as well as of 
practical banking insight. ^XThe outcome is remarkable. 
It would have been easy to go too far in either direction. 
On the one hand, due to a current belief that a control 
over credits was possessed by the larger banks of New 
York City, .there were many who regarded government 
control of banking credits as the only means for securing 
equality of treatment. This attitude was a part of the, 
present-day tendency to press for increasing govern^ 
mental interference with trade and industry. While 
there was opposition to a central bank of private capital 
and of private management, there was more or less sup- 
port for a central bank owned and controlled by the gov- 
ernment. Thus, although there was a well-preserved 
tradition in the Democratic ranks (based on ignorance 
of the real services of the Second United States Bank, and 



228 BANKING PROGRESS 

which did them little credit) against a central bank, and 
although Democrats were supposed to dislike a centrali- 
zation of political power, -yet the opposition to the plan 
of the National Monetary Commission was clearly due, 
not so much to fear of a central bank, as to the fear of a 
privately capitalized central institution which might be 
controlled by the "interests." 

On the other hand, sensible men of all parties realized 
that it would be impracticable to allow government offi- 
cials, often political appointees, to do the actual work 
of technical banking, to grant loans, to manage resources 
and investments — in short, to introduce the government 
into the banking business. Political control was obvi- 
ously as dangerous as private financial control; and it 
would have been destructively inefficient. 

The solution of the matter finally adopted was, inter- 
estingly enough, centralization by districts; that is, a 
centralization intended to prevent scattering of reserves 
was obtained by establishing in each district an institu- 
tion itself quite similar, in powers within its jurisdiction, 
to the national reserve association of the Monetary 
Commission. That is, the government was saved from 
going into the banking business by granting local cen- 
tralization with capital and management supplied by 
the banks, and yet federated under a common authority 
in order to establish governmental direction and unity 
of purpose. In its essence this plan retained the work- 
ings of local self-government, together with the operation 
of technical banking by those who supplied the capital, 
but under general direction. This final adjustment 
which secured safe and efficient methods, as contrasted 
with the chaotic proposals which might have been adopted, 
should be a cause of permanent congratulation. The 
nice balancing of powers between governmental super- 



THE FEDERAL RESERVE ACT 229 

vision and technical banking also appears in not going 
too far in local decentralization as illustrated in the de- 
velopment of our clearing-house operations. In these, 
because of the absence of any legal aids, local clearing- 
houses had been granting efficient banking service in 
times of panic, but in an isolated, unco-operative manner. 
Detachment went to extremes; each clearing-house was 
working without efficiency, because working by itself. 

It is to be observed, moreover, that the solution adapted 
to our conditions, in which a widely scattered system of 
individual banks had to be retained, must be original 
with us. In no other country were the conditions the 
same. The relation of a central bank in European states 
to other banks was not one based on the existence of a 
system of individualistic and numerous banks carrying 
on independent operations. Therefore, while retaining 
self-management of privately owned banks, co-operation 
was obtained by Reserve Banks in local districts under 
management by bankers, while country-wide and uni- 
form action was gained by governmental direction through 
a Federal Reserve Board. 

The difficulty of sectional differences of interest work- 
ing against each other would, nevertheless, have to be 
met in the practical workings of any plan. If there had 
been one central institution, pressure would have been 
brought upon the central management to help out one 
section of the country at the expense of another. Under 
a system of regional banks, each section gets the support 
of its own resources first of all, an arrangement by which 
sectional antagonism is reduced to the minimum. In 
addition, when one section is in trouble beyond its own 
powers of recovery, then by aid of the Reserve Board, 
one Reserve Bank may come to the aid of another. 
Such a practice, it is to be noted, had been going on in 



230 BANKING PROGRESS 

an extralegal way in previous years whenever the banks 
of a largo centre sought assistance from New York. 
Such a practice was natural and inevitable. In the new 
law such practice is openly recognized and legalized. It 
is, in effect, the same kind of action asked for by one 
borough, whose protective equipment has been taxed 
to excess by fire when it seeks the aid of another borough, 
not so threatened. 

A Federal Reserve Bank is to be established in each of 
at least eight, and in not more than twelve, districts, 
"apportioned with due regard to the convenience and 
the customary course of business" in the continental 
United States, excluding Alaska (Sec. 2). This was to 
be done by the organization committee, who have since 
agreed on twelve. Not only existing business and trans- 
portation relations must be considered, but also the nature 
of the industries, in order that all the resources of a dis- 
trict should not be invested in only one kind of paper 
presented at the same time. Obviously delimitations of 
districts may seem geographically curious, but yet be 
industrially correct. 

Each Reserve Bank will perform all the general func- 
tions of a typical bank, and its powers may briefly be 
enumerated as follows: 

1. To incorporate, have succession for 20 years, and sue and 
be sued (sec. 4). 

2. To appoint its own employees (sec. 4). 

3. To have all the special powers granted in this act, and all 
those incidental to carrying on its business of banking (sec. 4). 

4. To have a capital of not less than $4,000,000 (sec. 2). 

5. To establish branches in its district, and designate four 
of the seven branch directors (sec. 3). 

6. To pay dividends on stock, if earned (sec. 7). 

7. To determine the relative amount of credit granted to^ 
each bank (sec. 4). 



THE FEDERAL RESERVE ACT 231 

8. To obtain circulating notes after the manner of national 
banks in the interim before Reserve notes supersede national 
bank notes (sees. 4, 18). 

9. To provide compensation for directors (sec. 4). 

10. To be exempt from taxation (sec. 7). 

11. To elect a member of the Advisory Council (sec. 12). 

12. To pass on all discounts allowed by this act to member 
banks (sec. 13). 

13. To fix the rate of discount to member banks (sec. 14). 

14. To receive deposits from the Treasury or member banks, 
if it keeps 35 per cent reserves in gold or lawful money (sees. 
13, 16). 

15. To hold deposits from, and open accounts with, other 
Reserve Banks for exchange purposes (sees. 13, 14). 

16. To buy and sell in the open market bankers' acceptances 
and bills (sec. 14). 

17. To deal in gold coin at home and abroad; to borrow gold 
on security of government bonds, etc. (sec. 14). 

18. To buy and sell at home and abroad government securi- 
ties, bills, notes, revenue warrants, etc. (sec. 14). 

19. To maintain agencies, correspondents, and banking ac- 
counts abroad for dealings in bills of exchange (sec. 14). 

20. To receive government deposits, and act as fiscal agent 
for the United States (sec. 15). 

21. To present commercial collateral and obtain Federal 
Reserve Notes, if it holds a 40 per cent reserve in gold for them 
(sec. 16). 

22. To receive at par checks on member banks (sec. 16). 

23. To become a clearing-house for its district (sec. 16). 

24. To join in purchasing not over $25,000,000 per annum 
of United States bonds securing circulation, in allotments desig- 
nated by the Reserve Board (sec. 18). 

25. To have 2 per cent bonds refunded into 3 per cents 
(sec. 18). 

26. To examine member banks and their foreign branches 
(sec. 21). 

From this exposition it will be seen that each Federal 
Reserve Bank is to perform all the fundamental banking 
functions of issue, discount, and deposit; but that it is 



232 BANKING PROGRESS 

a bank for banks, and, with some exceptions to be noted 
later, not a bank for the public. Viewed from the stand- 
point of correcting existing evils in our banking and cur- 
rency system, it will be found, from our later discussion, 
that the Federal Reserve Banks are established for the 
purpose of providing (1) through the issue-function an 
elastic currency; (2) through the discount-function the 
much-needed elasticity of credit by a reorganization of 
our credit structure; and (3) through the deposit-func- 
tion an effective mobilization of bank reserves to secure 
co-operation in times of stress; and (4) the abolition of 
the antiquated independent treasury system. More 
than that, a possibility of an extension of the clearings- 
functions seems to open up. 

These facts disclose clearly that the Reserve Banks 
form the backbone of the whole system, and that its suc- 
cess will depend directly upon their management. Here 
is the crux of the whole matter. Upon the directors of 
these banks lies the heaviest responsibility arising from 
the new law. It is very much to be doubted if legislators 
or the public realize the practical difficulty of finding the 
men competent to assume this responsibility, and of in- 
suring a sound, intelligent, skilled, and judicious manage- 
ment. Consequently, the methods of choosing the di- 
rectors and officials are of first importance. The nine 
directors of each Reserve Bank have a term of three years, 
and are divided into three classes, A, B, and C (Sec. 4). 
The three members of Class A are supposedly to be 
bankers, and are chosen by the member banks of the 
district. The directors of each member bank choose 
one elector; from the total list of persons nominated, 
one by each bank, the electors are to choose the three 
directors of Class A. At the same time and by the same 
electors, three directors for Class B are to be chosen in 



THE FEDERAL RESERVE ACT 233 

the same way, who shall be men actively engaged in com- 
merce, agriculture, or industry within the district. The 
Reserve Board appoints the three members of Class C, 
who shall have been residents of the district for at least 
two years, and one of whom shall be designated as chair- 
man of the board of directors and also as the "Federal 
Reserve Agent." In short, the constituent banks have 
the power to choose more than a majority (six) of the 
nine directors of each Reserve Bank, while the represen- 
tative of the Reserve Board is always present. By this 
arrangement, technical banking operations are relegated 
to the Reserve Banks, and the responsibility for good or 
bad management is placed on the banks themselves, on 
the men whom they have elected. In choosing the di- 
rectors of Classes A and B, the member banks are to be 
divided into three general groups; "each group shall con- 
tain as nearly as may be one-third of the aggregate 
number of the member banks of the district and shall 
consist, as nearly as may be, of banks of similar capitaliza- 
tion" (Sec. 4). 1 

Much discussion was also had on the most desirable 
number of Reserve Banks. Irrespective of banking con- 
siderations, to politicians it was of course imperative to 
have one in each congressional "deestrict." To believers 
in a central bank, it was supposed that a small number, 
like four, could be made to work like one. The desire 
for decentralization, however, forced a larger number. 
But it was a mistake to fix upon any definite number at 
the outset. It would have been better to have started 
with the three central reserve cities (New York, Chicago, 
and St. Louis), having "regard to the convenience and 

1 Section 4 was amended June 21, 1917, and September 26, 1918. The di- 
vision of groups into one-third the aggregate number was dropped, and the 
procedure of election simplified. 



234 BANKING PROGRESS 

customary course of business," and to have given the 
Reserve Board power to increase the number of districts 
as time and experience demanded. In the working of 
the law as it stands, we shall probably have another 
illustration of the impossibility of legislation to change 
materially the natural tendencies of trade. The Reserve 
Bank in New York City will be the largest and most in- 
fluential because the banking capital and trade of New 
York City is, and will remain, the largest. In times of 
stress other parts of the country will continue to some 
extent to go to New York or Chicago for help, solely be- 
cause it is the place where help can be had. Yet, apart 
from these considerations, it should not be forgotten 
that the mere size of the capital of a bank is no measure 
of its lending power. In neither men nor banks is size 
a warrant of virtue. The quality of its management, the 
amount of its deposits, the character of its discounts are 
all of more importance to the efficiency of a Reserve Bank 
than the amount of its capital. 

So marked a departure from our past banking institu- 
tions and practices as is involved in the new law is cer- 
tain to encounter obstacles. The very existence of dis- 
counts, and earnings thereon, in a Reserve Bank depends 
upon the rediscounting of paper received in the course 
of business by member banks who wish to get assistance 
from a Reserve Bank; and yet rediscounting has been 
generally regarded in this country as suspicious, or as an 
evidence of weakness. The practical underhanded de- 
vices by which the need, indicated by rediscounting, has 
been actually met in the past would be wholly unneces- 
sary under the new act. Obviously, if banks of high 
standing and strength have recourse, as they undoubt- 
edly will, to rediscounting paper at a Reserve Bank, any 
small bank can do the same without casting suspicion 



THE FEDERAL RESERVE ACT 235 

upon its condition. What is normal and usual will cease 
to excite comment. But since rediscounting has been 
resorted to in the past only when it was desired to 
strengthen a bank's reserves, it has been held by some 
experienced bankers that recourse to the Reserve Banks 
for rediscounts will be had only in times of stringency, and 
that in normal conditions of trade the Reserve Banks 
will do little business. 1 

In anticipation of inactive funds, provision has been 
made to allow the Reserve Banks to engage in certain 
open-market operations. It is understood, of course, 
that it was expected these banks would discount only 
for member banks, and not for the public (except as later 
explained). The power to invest idle funds permits 
dealings at home or abroad in bonds and notes of the 
United States, and bills, notes, revenue bonds, and war- 
rants maturing in not over six months to anticipate 
revenues of any State or other division of the United 
States, or of irrigation, drainage, or reclamation districts 
(Sec. 14). Such dealings are to be carried on under rules 
of the Reserve Board, but the power is wide. Under 
"bills" is included, no doubt, "bills receivable," as men- 
tioned in the section preceding (Sec. 13). Such bills, as 
well as domestic bills of exchange, acceptances author- 
ized by this act, cable transfers, bankers' acceptances, 
and bills of exchange "of the kinds and maturities by 
this act made eligible for rediscount, with or without 
the indorsement of a member bank" may be bought and 
sold "either from or to domestic or foreign banks, firms, 
corporations, or individuals" by a Reserve Bank (Sec. 

J Any hesitation as to rediscounting was entirely overcome during the Eu- 
ropean War. In fact, the Federal Reserve Banks were pushed to the limit in 
carrying our government loans. So far did it go that the system could no 
longer be regarded as a recourse in any additional emergency. Cf. Chapter 
XI, §9. 



236 BANKING PROGRESS 

14). Here we have a surprisingly large departure from 
the limitation of business to member banks. It seems to 
suggest large possibilities of dealings with the public, 
if the paper is in the form of bills of exchange, etc. It is 
much to be doubted if the effect of these provisions has 
been fully foreseen. 

As regards dealing in public securities, or foreign bills 
of exchange, there can be little question; but it is to be 
noted that dealings in the securities of foreign govern- 
ments are not included. It was urged in behalf of a 
central bank that it was necessary to the maintenance 
of a sufficient fund of gold; and the experience of the 
Bank of France was an obvious example of what might 
be done. It is to be determined whether twelve Reserve 
Banks can preserve our gold supply as well as one central 
institution, or as it was done through New York in the 
past voluntarily. Very much can, of course, be done to 
regulate the international flow of gold by skilful dealings 
in foreign exchange; but here we may have no unified 
action. On the other hand, we are a gold-producing 
country; and the Reserve Banks can start with strong 
gold reserves behind their liabilities. Yet, apart from 
expected movements of gold on a considerable scale, we 
must face the possibility of a great and unexpected emer- 
gency. It is well known that in the past we have had 
no official institution capable of negotiating for gold 
with the great European banks. Will a separate Reserve 
Bank be regarded as satisfactory? Perhaps the New 
York Reserve Bank will be the one large enough to be 
relied on. However that may be, each Reserve Bank is 
given specific power "to deal in gold coin and bullion at 
home or abroad" and "to contract for loans of gold coin 
or bullion, giving therefor, when necessary, acceptable 
security, including the hypothecation of United States 



THE FEDERAL RESERVE ACT 237 

bonds or other securities which Federal Reserve banks 
are authorized to hold" (Sec. 14). Here will come in 
the suitability of the one-year 3 per cent notes not having 
the circulation privilege given in exchange for 2 per cent 
bonds having the circulation privilege (Sec. 18). 

§ 4. Apart from the effect of the Federal Reserve 
Act of 1913 on our credit system, its relations to our 
currency system will have special interest to the general 
public, notably to those who have been concerned with 
the struggles over government issues and free silver. 
For a long time this country had been facing a decision 
on the question whether the forms of money (irrespec- 
tive of the standard, be it gold or silver) needed as media 
of exchange in the daily round of business should be 
issued by the government, after the example of the United 
States notes (i. e. 9 greenbacks), or by the banks, after 
the example of national bank notes. 1 In order to deter- 
mine the bearing of the new law on this general ques- 
tion, a statement of the provisions regarding note-issues 
will first be given. 

No change is made in regard to any of the following 
forms of money: gold, gold certificates, silver, silver cer- 
tificates, and United States notes. Indeed, all past ques- 
tions touching the standard were definitely settled by a 
remarkable amendment in the House, now embodied in 
Sec. 26 of the new act, which emphasized the mainte- 
nance of the gold standard: 

Nothing in this Act contained shall be construed to repeal 
the parity provision or provisions contained in an Act approved 
March fourteenth, nineteen hundred, entitled "An Act to de- 
fine and fix the standard of value, to maintain the parity of all 
forms of money issued or coined by the United States, to re- 

1 Cf. the author's analysis in Money and Prices (1919), chap. X. 



238 BANKING PROGRESS 

fund the public debt, and for other purposes," and the Secre- 
tary of the Treasury may, for the purpose of maintaining such 
parity and to strengthen the gold reserve, borrow gold on the 
security of United States bonds authorized by section two of 
the Act last referred to or for one-year gold notes bearing in- 
terest at a rate of not to exceed three per centum per annum, 
or sell the same if necessary to obtain gold. 

Thus it was the act of 1913 rather than the act of 
1900 that practically established the gold standard. 1 

Likewise, the only provision affecting the greenbacks 
is that (Sec. 7) which devotes the net earnings from 
Reserve Banks accruing to the United States "to supple- 
ment the gold reserve held against outstanding United 
States notes," or to reduce the bonded indebtedness, at 
the discretion of the secretary of the treasury. 2 

The direct purpose of the new act is to replace the 
national bank notes, within a period of twenty years or 
more, by Federal Reserve notes. These notes are de- 
scribed as follows (Sec. 16) : 

Federal reserve notes, to be issued at the discretion of the 
Federal Reserve Board for the purpose of making advances to the 
Federal reserve banks through the Federal reserve agents as 
hereinafter set forth and for no other purpose, are hereby au- 
thorized. The said notes shall be obligations of the United 
States and shall be receivable by all national and member banks 
and Federal reserve banks and for all taxes, customs, and other 
public dues. They shall be redeemed in gold on demand at the 
Treasury Department of the United States, in the City of 
Washington, District of Columbia, or in gold or lawful money 
at any Federal reserve bank. 

These notes can be obtained only by a Federal Reserve 
Bank, on the deposit of an equal amount of commercial 
paper as defined by Sec. 13. Each note issued shall carry 

1 Cf. supra, pp. 3, 11. J Amended March 2, 1919. 



THE FEDERAL RESERVE ACT 239 

on its face the distinctive letter and serial number of the 
Reserve Bank putting it out, thus making each Reserve 
Bank responsible for the redemption of its own issues. 
That is, instead of United States bonds, as in the case of 
national bank notes, the ultimate security behind the 
Federal Reserve notes is to be commercial paper; in ad- 
dition these notes are also "a first and paramount lien 
on all the assets" of the issuing Reserve Bank. The 
Federal Reserve Board, through its federal reserve agent 
in each Reserve Bank, may charge the latter a rate of 
interest on these notes, at its option; and the board has 
the right, if it so chooses, to refuse entirely any applica- 
tion for notes. The comptroller of the currency shall 
provide the plates and dies, have a supply of notes ready 
for each bank, and charge all expenses to such banks. 
There is no limit to the total amount of such notes; and 
there is no tax when issues pass beyond a certain sum, 
except the possible charge of a rate of interest, as just 
mentioned. In effect, the supply of these notes is di- 
rectly related to the supply of rediscounted commercial 
paper, although the whole of any rediscount is not, by 
any means, likely to be paid out in notes. So much for 
the methods of issuing these notes. 

As regards the contraction of the notes when not 
needed, redemption is provided for by gold reserves of 
40 per cent against notes outstanding. No Reserve 
Bank shall pay out the notes of any other Reserve Bank 
under a penalty of 10 per cent; bat it is obliged to pre- 
sent such notes for credit or redemption to the bank that 
issued them. Likewise, Federal Reserve notes presented 
at the Treasury are redeemed out of a gold fund left with 
the Treasury by the Reserve Banks which shall not be 
less than 5 per cent (but counting as part of the 40 per 
cent reserve) ; and the Treasury will remit any notes thus 



240 BANKING PROGRESS 

redeemed to the respective Reserve Bank for reimburse- 
ment. A Reserve Bank, although required to hold re- 
serves of 40 per cent in gold against its outstanding notes, 
may redeem them either in gold or lawful money. When 
a Reserve Bank wishes to reduce its liability for Federal 
Reserve notes, even if its own notes are not obtainable, 
it may deposit with the federal reserve agent any Federal 
Reserve notes, gold, gold certificates, or lawful money. 
By these provisions, it is obvious that contraction of 
notes, not needed by the public, is fully provided for. 
In short, elasticity of note-issues — expansion in time of 
need and contraction when the need has passed — is fully 
provided. Furthermore, there can be no possible ques- 
tion as to their safety, secured as they are, first, by a gold 
reserve of 40 per cent; second, by the pledge of picked 
commercial paper to the par value of the notes; third, 
by a first lien on all the assets of the Reserve Bank; 
and, finally, by the guaranty of the United States — an 
obligation not likely ever to be called upon, in view of 
the prior protection. 

The language of the act (in Sec. 16) relating to Federal 
Reserve notes is equivocal. It is an obvious attempt to 
satisfy those who believe in government issues of paper 
money; while at the same time it is not the purpose 
seriously to impair the real functions of the issues as 
bank-notes. Thus the final outcome of the time-honored 
dispute, so far as reached by this act, seems to be in 
essence and in practical operation a settlement in favor of 
bank-notes; for the Federal Reserve notes are in no real 
sense government issues. The Treasury has no power to 
issue them in payment of governmental expenses; since 
the initiative must come from the Reserve Banks, and 
only on the offer of commercial paper originating in a 
private business transaction. Although not so stated 



THE FEDERAL RESERVE ACT 241 

literally, the notes are liabilities of the Reserve Banks, 
since they must redeem them, and since the notes are a 
first lien on all the assets of such banks. To state that 
the notes are the obligations of the United States and 
may be redeemed at the Treasury is only "a frill," of no 
practical import; since it is unlikely that the government 
Would ever be called upon to meet this obligation. To 
say that, in issuing the notes, the Treasury is "making 
advances" to the Federal Reserve Banks is meaningless 
(and, if it serves a political purpose, no harm is done); 
since the action of the board in passing out notes in re- 
turn for a pledge of commercial paper is as purely admin- 
istrative as the present action of the comptroller in 
handing over printed national bank notes in return for 
a pledge of United States bonds. Nothing in the words 
of the act can be construed as making these notes gov- 
ernment issues, any more than national bank notes are 
government issues. 1 On this outcome, and on the escape 
from serious monetary error, the country is to be con- 
gratulated. 

The law looks forward to a new basis for the bank- 
note circulation which has been formerly based on United 
States bonds. These notes are eventually to be dis- 
placed with Federal Reserve notes based on commercial 
paper. This displacement, involving the disposal of 
$740,000,000 of United States bonds now used to secure 
circulation, will be treated later. 

A national bank entering the new system is not, how- 
ever, obliged to give up its present circulation; and the 
withdrawal of national bank notes by existing national 
banks is tied up with the disposal of the bonds to which 

1 It is not worth while to give attention to the claim that Federal Reserve 
notes are "fiat money," on the ground that, being government obligations, 
the government makes no provision for their redemption. Other provisions 
remove them from this imputation. 






242 BANKING PROGRESS 

the circulation privilege is already attached. Nor are 
national banks obliged to present their bonds for ex- 
change into others having no circulation privilege under 
Sec. 18, unless they choose. Consequently, the displace- 
ment of existing national bank notes by Federal Reserve 
notes will be long deferred. If it were possible to dispose 
of the bonds amounting to $740,000,000 to the full satis- 
faction of the banks, how could an equal amount of 
Federal Reserve notes be issued to take their place ? Since 
the latter were to be secured only by commercial paper, 
instead of bonds, it follows that there would have been 
a considerable contraction of bank-notes, unless the 
Reserve Banks had prime discounted paper on hand to 
at least $740,000,000. Obviously, this sum could not be 
counted on; and a contraction of the currency would not 
have been politically wise. Hence the provisions of the 
House bill, allowing a more or less rapid substitution of 
Reserve notes for national bank notes, were dropped by 
the Senate. Of course, under the new act, quite inde- 
pendently of the national bank circulation secured by 
bonds, Federal Reserve notes may be issued at any time 
to any amount according to the provisions of Sec. 16. 
If issued, they would be an addition to the existing national 
bank circulation; and the security behind them would 
be commercial paper, not bonds. 1 

If, however, national banks prefer to sell their bonds 
they may do so, after December 23, 1915, and within a 
period of twenty years thereafter, in limited amounts 
each year (Sec. 18). The bonds thus disposed of by the 
banks are to be taken over by the Federal Reserve Banks; 
and the latter are then to be allowed to take out national 
bank notes on depositing these bonds with the comp- 
troller, in the same way as national banks did; although 

1 See act of June 21, 1917, and Chapter XI, § 8. 



THE FEDERAL RESERVE ACT 243 

they are not obliged to do so. 1 To the extent that Fed- 
eral Reserve Banks should not take out notes on the 
bonds they have acquired there would be a contraction 
of the national bank circulation. But it is planned to 
prevent any considerable contraction of the national 
bank circulation, even if the national banks dispose of 
their bonds (cf. Sec. 4, Eighth). The final disposal of 
these bonds by the Federal Reserve Banks will be dis- 
cussed later. 

Understanding that the national bank circulation is 
not likely to be much reduced for the present, while the 
Reserve Barks may at any time add to the existing mon- 
etary supply, are we to expect, so far as notes are con- 
cerned, an undesirable expansion? By expansion must 
be meant the tendency to grant loans, through the too 
great ease of issuing notes or granting credits, without 
due regard to the soundness of the transaction giving 
rise to commercial assets. So long as loans are carefully 
restricted to safe loans based on an actual exchange of 
goods no swelling of liabilities occurs which must be 
finally reduced by forced liquidation. That is, undue 
expansion has its origin in excessive, or unsound, loans. 
An extension of bank-notes, then, can cause expansion 
only so far as it aids in an expansion of loans. If so, 
how will the note-issues under the new act work? 

An increase in bank-notes can be used for two general 
purposes: (1) to satisfy the need of a medium of exchange 
in the hands of the public; or, {%) to supply bank reserves. 
In the former case, if pocket-money and till-money is 
already sufficiently supplied, then, unless the monetary 

1 If these notes are issued to Federal Reserve Banks under the same condi- 
tions as to national banks, the former must pay the tax of 3^ of 1 per cent, if 
the bonds pay only 2 per cent; but in Sec. 7 the former are free from federal 
taxation. Cf. Conway and Patterson, The Operation of the New Bank Act, 
pp. 138-139. 



244 BANKING PROGRESS 

customs of the people have changed, no more bank-notes 
will remain in circulation, provided they are redeemable 
in gold or lawful money. In the latter case, the Federal 
Reserve notes cannot be kept as reserves by member 
banks. But, it is said, they may be presented, the same 
day they are obtained on a loan, for gold and lawful money 
by which reserves could be enlarged. On the contrary, 
if a member bank wished to increase its reserves by a 
rediscount, it would not need to draw notes at all, but 
would leave the proceeds of the loan to its credit at the 
Reserve Bank, in which form it is ipso facto added to its 
reserve account. There still remains, however, the pos- 
sibility of getting Federal Reserve notes and exchanging 
them for lawful money at a non-member bank which 
can use Federal Reserve notes as reserves. 1 There would, 
however, be no more reason for this action than for the 
one just mentioned, since it would be less trouble to 
leave the proceeds of a loan at a Federal Reserve Bank 
on deposit where it would count as reserve. For these 
general reasons, then, there does not seem to be any 
ground for apprehension that the Federal Reserve notes 
will, if based only on commercial paper, be so put into 
circulation as to cause expansion. If any such expan- 
sion is intended, it can be more easily accomplished, 
without the use of the notes, through loans, deposit- 
accounts, and checks. 

There are those, however, who measure expansion by 
the increase of prices. They probably hold that an ad- 
dition to the circulation, according to the quantity- 
theory of prices, would raise prices; also, that an exten- 
sion of loans, without the use of bank-notes, would stim- 
ulate credit and raise prices. 2 Redemption, on the other 

1 Cf. Conway and Patterson, op. tit., p. 152. 

2 Cf. O. M. W. Sprague, "The Federal Reserve Act of 1913," Quarterly Journal 
of Economics, February, 1914, p. 240. 



THE FEDERAL RESERVE ACT 245 

hand, would always force a test of the solvency of the 
transaction on which the credit is based; thus credit is 
kept wholesome and normal, so long as unsound loans 
are prevented. 1 A possibility of undue inflation is sug- 
gested, it may be mentioned, by such a reduction of re- 
serve requirements as would weaken the certainty of 
redemption; but this consideration could not apply to 
the Federal Reserve notes, under this act. 

§ 5. The removal of a bank circulation secured by 
United States bonds having been determined upon by 
general consent, a practicable and just disposal of the 
$740,000,000 bonds has not been easily found. The 
largest part of these bonds yield only 2 per cent; solely 
as an investment they would sell below 70; but, since 
they have the "circulation privilege" (or right to serve 
as security for national bank notes), the demand for them 
by national banks in the past has kept them above par, 
some having sold even as high as 110. When the new 
bill appeared, the national banks were directly con- 
cerned with the possibility of losses on their bonds, if 
the circulation privilege were withdrawn from them. In 
the proposed law the treatment of these bonds was the 
problem least well thought out. 

When the Glass Bill became known, June 18, 1913, it 
contained sections then numbered 18, 19, and £0. Sec. 
18 provided that no national bank should issue notes in 
excess of the amount outstanding at the passage of the 
act; Sec. 19 repealed the former acts requiring banks to 
hold bonds to the amount of one-fourth of their capital 
(if less than $150,000) ; and Sec. 20 required the secretary 

1 "The security against the consequences of inflation is not to be found in 
the limitation or extinction of notes, but in specie redemption for all liabilities, 
and in the encouragement given sound banking by steady oversight and pub- 
licity" (C. F. Dunbar, Economic Essays, p. 185). 



246 BANKING PROGRESS 

on application to exchange the 2 per cent bonds having 
the circulation privilege for 3 per cents not having this 
privilege (but payable twenty years from date and ex- 
empt from all taxation) to an amount each year not ex- 
ceeding 5 per cent of the total quantity of bonds held 
by the Treasury, while, as fast as the 2s were refunded, 
"the power of national banks to issue circulating notes 
secured by United States bonds shall cease and termi- 
nate"; and at the end of twenty years all the 2s should be 
exchanged for 3s, and all national bank notes should be 
recalled and redeemed. 

To most politicians the note question is of primary 
importance; indeed, to allow banks under any circum- 
stances to issue notes is to grant the "money-power" a 
privilege. Conferences of leaders were held. Senator 
Owen, chairman of the Senate committee, demanded 
the omission of Sees. 18, 19, and 20 in order that the 
question might be left to future legislation; and he gained 
his point. Then, on the representation of a committee 
of the American Bankers' Association, these sections of 
the bill were reinserted; and on June 26, 1913, the bill 
including them was introduced into the House and 
Senate. 

As these sections stood, the 2s could not be sold in 
the future to secure circulation, since no more national 
bank notes could be issued than were outstanding at the 
passage of the act; and the only outlet would be their 
exchange for 3s. On June 28 the financial columns of 
the press noted a decline in the price of the 2s to par. 
At the best they could not sell higher than the 3s into 
which they were to be exchanged; and European states 
were not able to borrow at par at 3 per cent. Just at 
that time a tendency of the interest rate on permanent 
investments toward a higher level showed itself. It 



THE FEDERAL RESERVE ACT 247 

might be that within the term of twenty years the 3s 
might not be worth par, it was said; thus, somehow, 
the belief spread that on the passage of the act the cir- 
culation privilege would be practically taken away. 
But, whatever the reason, timid holders of the 2s began 
to throw them on the market; hence, as the demand 
was small, a very few offers were sufficient to send down 
the price, and during July they were quoted at 95. 

United States bonds (including 2s) had also been used 
to secure government deposits with the banks (some $50,- 
000,000). If by the new act government deposits were 
to be transferred to the Federal Reserve Banks, then the 
demand for 2s (or any other United States bonds) as a 
security for deposits would to that extent be diminished. 

This embarrassing situation 1 brought out a statement 
from Washington about the middle of July that Sec. 20 
would be so modified as to allow all banks to take out 
circulation on the 2s as long as they were not exchanged 
for 3s; that the exchange of 2s into 3s would be per- 
missive; and that at the end of twenty years the holder 
of 2s would receive par and accrued interest in cash. 
In effect, the circulation privilege was to be restored. 
I. was also stated that Sec. 18 had been left in the bill 
by error; and when the bill was presented to the House 
caucus August 15, Sec. 18 had been omitted. More- 

1 As a consequence of the fall in the prices of the 2s, Secretary McAdoo on 
July 28, 1913, made the following statement to the public: 

"The 2 per cent bonds are worth par, notwithstanding their decline in the 
New York market, a decline due not to any impairment of their intrinsic value, 
but ^almost wholly to what appears to be a campaign waged with every indica- 
tion of concerted action on the part of a number of influential New York city 
banks to cause apprehension and uneasiness about these bonds, in order to 
help them in their efforts to defeat the currency bill." 

The banks retorted that it was unlikely they would try to impair the value 
of their own assets amounting to $740,000,000. On the other hand, the state- 
ment might have retained radical support in Congress for a bill supposed to 
be antagonized by the large banks. 



248 BANKING PROGRESS 

over, at this time (July 31) Secretary McAdoo announced 
he would deposit $25,000,000 to $50,000,000 of govern- 
ment funds with the banks of the South and West to 
relieve any autumnal stringency. To get these deposits 
banks must have outstanding at least 40 per cent of their 
authorized circulation, and if they pledged government 
bonds these would count as par against deposits. To that 
extent the demand for United States bonds would be in- 
creased and their price be raised. 1 

Finally, in the later stages of this legislation, the present 
provisions regarding bonds were inserted in Sec. 18 of 
the new act. After December 23, 1915, and for twenty 
years thereafter, any member bank wishing to retire its 
circulation may offer its bonds at par to the Treasury of 
the United States; at the end of each quarter, the Fed- 
eral Reserve Board may require each Federal Reserve 
Bank to purchase a certain proportion of the bonds of- 
fered. The Reserve Banks may then take out notes, 
under the same conditions as national bank notes, equal 
in amount to the bonds they have purchased. If they 
do this, there will be no contraction of notes secured by 
bonds. 

It is expected, however, that Federal Reserve Banks 
will not present to the comptroller all their bonds as se- 
curity for notes; since any Reserve Bank may have its 
2 per cent bonds against which no circulation is out- 
standing refunded, one-half into thirty-year 3 per cent 
gold bonds without the circulation privilege, and one- 
half into one-year gold notes of the United States bearing 

1 Furthermore, State and municipal bonds, etc., other than bonds of the 
United States, would be accepted at a valuation of only 75 per cent, and prime 
commercial paper at 65 per cent. This was the first time commercial assets 
were ever permitted under the act of March 4, 1907 (Sec. 3) to be used as 
security for government deposits. Since the passage of the present act, it has 
no further importance, except that it went far beyond the action of Secretary 
Shaw, so much criticised in his time. 



THE FEDERAL RESERVE ACT 249 

3 per cent interest, without the circulation privilege. 
Thus, instead of the 2s, it may have long-term 3 per 
cent bonds which it can sell in the open market, and one- 
year notes which will be highly useful in borrowing gold 
in any foreign market. To the extent that Federal Re- 
serve Banks refund their bonds the national bank cir- 
culation will be reduced; but at no time will the bonds 
held by member banks lose their circulation privilege, 
and after two years from the passage of the act they can 
be sold at par in amounts of not more than $25,000,000 
in any one year. It follows, therefore, that not all the 
bonds can be disposed of in twenty years. 

§ 6. The lending power of a bank, whether the loan 
is carried through by notes or by a deposit-account given 
to the borrower, is influenced by the regulations affect- 
ing reserves, which are the cash means for meeting de- 
mand-liabilities. On this important feature, it should 
be noted that the plan of the National Monetary Com- 
mission made no changes in the old system of reserves. 
Under the old national banking system, country banks 
were obliged to hold 15 per cent reserves in lawful money 
against deposits, of which 9 per cent could be kept with 
banks in reserve or central reserve cities; the banks in 
the forty-seven reserve cities were obliged to hold re- 
serves of 25 per cent, of which 12}^ per cent could be 
kept with banks in central reserve cities; while banks in 
the three central reserve cities had to maintain reserves 
of 25 per cent. Moreover, the required redemption fund 
of 5 per cent of outstanding circulation could be counted 
toward reserves for deposits. This redepositing of re- 
serves in trade centres arose for business reasons: cus- 
tomers of local banks needed drafts, or exchange, on 
cities where they purchased goods; and such banks had 



250 BANKING PROGRESS 

to keep funds there on which to draw. That is, rede- 
positing of reserves was due to the need of exchange. 
Whether there were reserve laws or not, funds would 
have converged where the most goods were bought and 
sold. Some centralization of cash in this way was normal 
and inevitable. 

By selling exchange on large city banks a local bank 
creates demand-liabilities at a distance; yet it has de- 
mand-liabilities in its deposit-accounts at home. The 
two things are different and lead to much confusion of 
mind. The sum kept with a city correspondent to cover 
exchange is really only a checking account, and in no 
sense a real reserve in cash that can be called for on de- 
mand; it is constantly being wiped out and replenished 
by miscellaneous items. But under the delusion that 
these funds are reserves (strengthened by the fact that 
the law permits them to be called legal reserves), local 
banks seem to think they can call on them in time of 
stress; then, of course, they cannot get the cash, and are 
highly indignant. In truth, checking accounts to cover 
exchange are not real banking reserves. This considera- 
tion should be kept in mind in studying the effect of the 
reduction of the percentage for reserves in the new act. 

For demand-deposits, in the new law, a country bank 
was required to maintain reserves of 12 per cent; three 
years after the establishment of the Federal Reserve 
Banks, 4 per cent must be kept at home, 5 per cent in 
the Federal Reserve Bank, and the remaining 3 per cent, 
either at home or with the Reserve Bank at the option of 
the country bank. 1 That is, after three years, no funds 
left with city correspondents could be counted as legal 

1 In the transition period of three years the country bank must keep 5 per 
cent at home; in the Federal Reserve Bank for the first twelve months 2 per 
cent; and for each succeeding six months an additional 1 per cent, until 5 per 
cent was reached. 



THE FEDERAL RESERVE ACT 251 

reserves. In short, funds to cover exchange, so long as 
it was drawn on city correspondents, must be carried 
independently of legal reserves. On the other hand, if 
exchange is drawn in the future on the Federal Reserve 
Banks, or branches (instead of on other banks), funds 
counted as reserves will still be used to cover exchange. 
Therefore, the reduction in the minimum requirement 
from 15 to 12 per cent reserve is more nominal than real. 

A reserve city bank, in the new act, is required to 
maintain reserves of 15 per cent of its demand-deposits; 
after three years, 5 per cent shall be kept at home, 6 
per cent in its Federal Reserve Bank, and the remaining 
4 per cent either at home or with the Reserve Bank at 
option. 1 As with country banks, no deposits in other 
banks will then count as legal reserves. 

A central reserve city bank was required to hold re- 
serves of 18 per cent against its demand-deposits, of which, 
from the beginning, 6 per cent must be kept in its own 
vaults, 7 per cent in its Federal Reserve Bank, and the 
remaining 5 per cent either at home or with its Reserve 
Bank at its option. 

Inasmuch as items passing from a depositing bank to 
its reserve agent should not be counted as reserves until 
collected, they should not be included by the reserve 
agent as deposits on which reserves are to be computed. 
The new act, therefore, enacted (Sec. 20) that "in esti- 
mating the reserves required by this Act, the net balance 
of amounts due to and from other banks shall be taken 
as the basis for ascertaining the deposits against which 
reserves shall be determined. Balances in Reserve Banks 

1 In the transition period of three years such a bank must keep 6 per cent at 
home; in the Federal Reserve Bank for the first twelve months 3 per cent; 
and for each succeeding six months an additional 1 per cent, until 6 per cent 
was reached. For changes before the transition period expired, in all three 
classes, see Chapter XI, § 2. 



252 



BANKING PROGRESS 



due to member banks shall, to the extent herein provided, 
be counted as reserves." 

For all these classes of banks a new distinction is in- 
troduced between demand and time deposits: demand- 
deposits comprise all those payable within thirty days, 
and time-deposits all those payable after thirty days, 
including savings-accounts, etc., subject to thirty days' 
notice. Any bank is required, in addition to the above 
requirements for demand-deposits, to hold only 5 per 
cent reserves against time-deposits. As nearly as can 
be estimated, about one-third of the deposits of country 
banks are time-deposits; of reserve city banks, about 
8 per cent; of central reserve city banks, about 1 per 
cent. Taking into account both the reduction of re- 
serves against demand-deposits, and that due to the 
low rate on time-deposits, the nominal reserves (irrespec- 
tive of redepositing) have been lowered in the new law 
by more than one-third, as may be seen from Table I, 
based on the reports of the condition of national banks, 

March 4, 1914: 

TABLE I 

[In millions] 



March 4, 1914 


Net 
deposits 


Total 
time- 
certifi- 
cates 


Total 
savings- 
deposits 


Total 
time- 
deposits 


Required 
reserves 

under old 
system 


Required 

reserves 

under new 

system 


Reserves 
released 
under 
new act 


Country banks 
Reserve city 

banks 

Central reserve 

city banks . . . 


$3,761 
1,970 
1,773 


$485 
59 
15 


$777 
93 

1 


$1,262 

152 

16 


$564 
492 
443 


$363 
280 
317 


$201 
212 
126 


Totals 


$7,504 


$559 


$871 


$1,430 


$1,499 


$960 


$593 



Although the nominal reserves, especially of country 
banks, have thus been lowered, there remains the problem 
of the effect on the banks and on business of the transfer 



THE FEDERAL RESERVE ACT 



253 



of reserves, if any, from the reserve city banks to the 
Federal Reserve Banks. As to the sums which must 
be at once moved to comply with the law, the com- 
putations 1 which have been made show clearly that the 
cash holdings of the various classes of banks are more 
than sufficient to cover the transfers of the reserves, the 
payment of the required 3 per cent on the capital sub- 
scription of 6 per cent upon capital and surplus, and to 
retain enough reserves in their own vaults to meet the 
requirements of the act. That is, it would not be neces- 
sary for banks to call upon their reserve agents to cover 
the initial payments to the Federal Reserve Banks; but 
it is assumed that one-half of the reserves to be first 
paid into the Federal Reserve Banks could be obtained 
(as permitted in Sec. 20) by deposit of eligible commercial 
paper (as described in Sec. 13). In short, these figures 
present the minimum transfers in initiating the new 
system. 

In viewing the effect of the transfer of funds on busi- 
ness loans, it is to be noted that, of course, the whole of 
the amount deposited by local banks in reserve city banks 
is not needed merely to cover exchange. As is well 
known, the payment of 2 per cent interest on deposits 



1 Cf. W. A. Scott, "Banking Reserves Under the Federal Reserve Act," 
Journal of Political Economy, April, 1914. 

[In millions] 



January 13, 1914 


Country banks 


Reserve city 
banks 


Central reserve 
city banks 


Total cash holdings 


$284.0 

37.4 

29.8 

186.9 

29.7 


$286.6 

28.6 

13.4 

114.4 

112.2 


$429.2 

55.3 

10.4 

94.8 

268.5 


One-half deposit of reserves 

3 per cent subscription to capital. . 

Reserves required at home 

Balance of cash holdings 



See also the figures of Conway and Patterson, op. cit., pp. 251-252, 259, 
267-269, 272, 275-276, 299, 301, 306. 



254 



BANKING PROGRESS 



by reserve agents attracts funds when idle at home; and 
a large deposit-account with its city correspondent gives 
the local bank corresponding advantages of treatment. 
In the report of same date the figures were as given in 
Table II. 

TABLE II 

[In millions] 



March 4, 1914 


Cash and 5 per cent 
redemption fund 


Deposits with 
reserve agents 


Country banks 


$291 
261 
449 


$551 
286 


Reserve city banks 


Central reserve city banks 




$1,001 


$837 



The total net deposits of national banks subject to 
reserve requirements at that date were $7,504,000,000. 
Thus the actual cash of $1,001,000,000 was only 13.3 
per cent of deposits; since the $837,000,000 of deposits 
with reserve agents was not cash. Hence the demand 
of member banks upon their reserves in the reserve cities, 
if made, for transference to Federal Reserve Banks 
would really fall upon the $1,001,000,000 of cash actually 
held in the present system. 

The important consideration, however, lies in the effect 
on the lending power of the banks after and because of 
these transfers. With the balances left over in their 
reserves, could they still care for their customers ? That 
question is obviously the one which forced the banks 
to be cautious with loans until the adjustment was finally 
completed. There are, however, two matters which might 
relieve any possible tension. In the first place, the above 
computation has not called for withdrawals from reserve 
city banks. It is well to be on the safe side in this 
matter; for the reserves with reserve city banks could not 



THE FEDERAL RESERVE ACT 255 

be called upon to any extent in cash, since they are 
themselves the basis of loans made by the city banks. 
But, in the second place, the most important and effec- 
tive method of taking care of the needs of customers in 
the transition period, and the one which would keep 
credits flexible, would be the rediscounting of short- 
time paper by member banks at the Federal Reserve 
Banks. The immediate effect of such a rediscount 
would be an increase of the reserves of the member bank, 
so long as the proceeds of the rediscount were left with 
the Federal Reserve Bank. 

In addition, the use of government deposits in this 
transitional period would be a very important element. 
The deposits of the United States then held by national 
banks was about $58,000,000; while the other funds of 
the Treasury would allow the deposit of a much larger 
sum with the banks. Instead of placing large amounts 
with Federal Reserve Banks at the outset, it might be 
wise to aid the member banks by additional deposits. 

As a counterweight to this possible restriction on loans, 
it should be kept in mind that the deposits of funds 
with city correspondents to cover exchange would no 
longer be so necessary, if instead exchange were drawn on 
the Federal Reserve Banks where funds existed to cover 
such drafts. To be sure, the payment of 2 per cent in- 
terest on deposits with the city banks, and the tendency 
to continue long-established relations with these agents, 
would work to retain the old exchange methods and to 
keep funds with city correspondents. 

The general effect of the changes in the reserve system 
seem, on their face, to make easier an expansion of 
credit. That is, less cash reserves need to be carried; 
but member banks would have no reason for carrying 
as high reserves as in the past, if they hold short-time 



256 BANKING PROGRESS 

paper such as they can use in getting discounts from the 
Federal Reserve Banks. And yet, in the transitional 
period, we are likely to see more or less caution and re- 
striction of credit. That is, at the start, the tendencies 
toward expansion and restriction very nearly balance 
each other. 

As concerns the reserves of the Federal Reserve Banks, 
as distinct from member banks, there is a requirement 
of a 35 per cent reserve against deposits to be kept in 
gold or lawful money; and against outstanding Federal 
Reserve notes a reserve of 40 per cent in gold. Any re- 
serve requirements specified in this act, however, may 
be suspended for thirty days (and later for fifteen days 
at a time) provided a graduated tax is imposed on the 
deficiencies. Further it is enacted (Sec. 11 (c)) : 

That when the gold reserve held against Federal reserve 
notes falls below forty per centum, the Federal Reserve Board 
shall establish a graduated tax of not more than one per centum 
per annum upon such deficiency until the reserve falls to thirty- 
two and one-half per centum, and when said reserve falls below 
thirty-two and one-half per centum, a tax at the rate increas- 
ingly of not less than one and one-half per centum per annum 
upon each two and one-half per centum or fraction thereof 
that such reserve falls below thirty-two and one-half per cen- 
tum. The tax shall be paid by the reserve bank, but the re- 
serve bank shall add an amount equal to said tax to the rates 
of interest and discount fixed by the Federal Reserve Board. 

Under the provisions of the act, a Federal Reserve 
Bank might carry no gold at all behind its deposits, and 
only the 40 per cent of gold behind its notes; since even 
then it could redeem its notes in lawful money. Thus 
the gold reserve beyond the 40 per cent behind notes is, 
in effect, available for either of the two demand-liabili- 
ties, deposits or notes. 



THE FEDERAL RESERVE ACT 257 

§ 7. The Federal Reserve Act of 1913 undoubtedly 
opens for this country an entirely new epoch in the opera- 
tions of credit and currency. Possibly because the de- 
velopments in credit and in the mechanism of exchange 
have produced momentous changes in the last fifty or 
seventy-five years, it is safe to say that an act which 
should fully meet the conditions of to-day must be more 
important than any previous banking statute, not ex- 
cepting the National Banking Act of 1864, or the act 
of 1791 establishing the first United States Bank. Cer- 
tainly no previous measure has attempted to strike di- 
rectly at the long-recognized rigidity of our credit system, 
which has itself led to unnecessary paroxysms of trade 
in the past, and which has also brought to light the under- 
lying weaknesses of our currency system. For, wider 
and deeper than the inelasticity of our circulation has 
been the inelasticity of our credit system. And yet, 
until this act, practically the whole attention of reform- 
ers had been directed to creating an elastic note system. 
In the work of the Indianapolis Monetary Commission 
of 1898 this was eminently true. 

So far-reaching a measure as this demands comparison 
with the great enactments of other countries, especially 
with the English Bank Act of 1844. That law was passed 
to meet a situation not unlike our own: gold redemp- 
tion had been secured since 1821; crises had been dis- 
agreeably destructive; it was desired to have a note- 
circulation which would act like gold; as with us now, 
the use of checks drawn upon deposit-accounts had been 
growing; but it was generally believed that all difficul- 
ties were traceable to the note-issues. Then came the 
act of 1844, which set the notes off by themselves in the 
issue department; while the deposit and discount func- 
tions were relegated solely to the banking department. 



258 BANKING PROGRESS 

With what result? That the operations of credit, inde- 
pendent of the note-issues, could, through the banking 
department, provide the most effective of all media of 
exchange (the deposit-currency); they could expand 
with trade; they could develop overtrading and crises; 
they could produce all the results formerly charged solely 
to note-issues. The unintended lessons of the Bank 
Act of 1844 are the most important in our monetary litera- 
ture. Although the act represented the doctrines of the 
currency school, its actual operations were the triumph 
of the banking principle. 

So with our act of 1913: while to many the matter of 
chief importance has seemed to be the note-issues, the 
real heart of the measure is to be found in the purely 
banking functions of discount and deposit. Not only are 
these pivotal, but they dominate the whole question of 
the note-issues. In our own country the struggles as- 
sociated with the greenbacks and silver have centred at- 
tention on the circulation and the quantity of it in use. 
They have influenced the attitude toward bank-notes by 
leading some politicians, as before noted, to think that 
the issue of notes by banks would enable these banks to 
control the "money market" and the credit operations 
of the country. Moreover, the last previous act (the so- 
called Aldrich-Vreeland Act of 1908), intended to pro- 
tect the country against possible panics, was based 
throughout on the assumption that credit emergencies 
could be met by an issue of national bank notes through 
currency associations. Yet in the serious emergencies in 
the autumns of 1912 and 1913, no resort was made to the 
act of 1908. Nevertheless, so firmly intrenched in the 
minds of our public men was the belief in the issue of 
notes to relieve a crisis that in the law of 1913 the act of 
1908 was extended for another year; and the secretary 



THE FEDERAL RESERVE ACT 259 

of the treasury assured the country that the act would 
be resorted to if necessary. 

As the result of our exposition in preceding chapters, 
we may at the risk of repetition summarize the truth as 
to notes and deposits. When a loan is made by a bank 
it creates a demand-liability in favor of the borrower that 
can be met either by its own notes (or cash from its 
reserves) or by a deposit-account. Whether notes, or 
checks drawn on deposit-accounts, are used by the bor- 
rower depends on the kind of transaction, or on the busi- 
ness habits of the community where he wishes to make 
a payment. The elasticity so much extolled may be de- 
manded in two different cases. In the first place, the 
seasonal demand for currency in the autumn had exposed 
the inelasticity of both our note and credit systems. It 
gave strong support to those who think our troubles 
centre in the currency. Why ? Because in the past the 
demand both for strengthening reserves and for paying 
customers has been a demand for some form of money. 
Hence the emphasis on the need of an elastic currency; 
and so far as this need of actual currency exists it is of 
course imperative. But this is only a part of the truth, 
and not the most important part of it. 

In the second place, the demand which comes in time 
of a panic brings us to the very core of the matter. Here, 
although to many minds even panic conditions are sup- 
posed to demand treatment in the form of additional 
issues of notes, the real need is for elasticity of credit. 
Where we have the deposit-currency well developed (as 
in the United States and Great Britain), there is no lack 
of a medium of exchange. Even in the worst of the crisis, 
if a borrower can obtain a loan, he has no difficulty in 
getting a medium of exchange. Consequently, the need 
of actual money is then of importance primarily as it 



260 BANKING PROGRESS 

affects the reserves of banks and their lending power. 
Of course, a bank's own notes cannot be used in its re- 
serves. Hence the real neeH is to stop the drain on cash 
reserves, or to obtain that by which reserves can be re- 
plenished. How can this be done? And how does the 
new act afford help at this point? 

In the past, the National Banking Act caused rigidity 
of credit through its regulations touching not only its 
note-circulation but also its reserves; and most of all 
by the absence of all provisions for converting good com- 
mercial paper into a means of payment — whether the 
borrower calls for notes or uses a deposit-account. That 
is, the system was so constructed that when customers 
were in the most trouble and most needed help — when 
bank reserves were being drawn down — the bank was 
obliged to refuse new loans, to contract existing loans, 
to sell any available assets it had for cash, and to try to 
increase the ratio of its reserves to its demand-liabilities. 
Under the new act, just the reverse will be true. In 
times of distress there will be no need of contracting 
credit; in fact, the only time when it may be necessary 
to contract credit will be to check possible expansion 
during a tendency to overtrade (which will be discussed 
later). So far as borrowers, or the public, need forms of 
money in exchanging goods, or for various other needs, 
Federal Reserve notes can be obtained so long as banks 
holding good commercial paper demand such money. 
Therefore, irrespective of the elastic deposit-currency, 
there will be no inelasticity of a medium of exchange for 
tke public; it can be had as needed, at any time. 

But how does the act touch the reserves and the re- 
discounts so that it may bring about the much-desired 
elasticity of credit? This is the nerve-centre of the 
whole act. The pivotal provisions are those which allow 



THE FEDERAL RESERVE ACT 261 

any member bank to have certain kinds of short-time 
paper rediscounted at its Federal Reserve Bank. At 
this institution the loan creates in favor of the borrowing 
bank a deposit-account. Then the pith of the operation 
resides in the fact that all sums kept on deposit at a Re- 
serve Bank count as legal reserves for the given member 
bank. That is, the rigidity of credit-banking in the past, 
the destructive snatching for reserves, are displaced by 
a system which allows good commercial paper — under 
certain limitations — to be converted into lawful reserves. 
This is the process which directly touches the lending 
power of a member bank to its customers. Therefore, 
in a time of panic — if any such arrives — there will be no 
reason for a run on cash reserves, or, if there is a sem- 
blance of it, there will be a quick and ready way by 
which the reserves can be replenished. There can be no 
serious run on the cash by the public, because the mem- 
ber bank can furnish at will reserve notes, by making 
request for them at the Reserve Bank and having them 
charged against its deposit-account there. But it must 
still be kept in mind that banks deal primarily in credit, 
and only incidentally in money. Goods, when sold, and 
which form the basis of commercial paper, are thereby 
coined into a means of payment, and give rise to their own 
medium of exchange without necessarily calling on any 
forms of money. And yet the elasticity of the notes and 
of credit are, as they should be, linked together. In short, 
both notes and deposits (on which checks can be drawn) 
respond directly to the volume of commercial loans; and 
these loans are directly related to the general volume of 
goods bought and sold. Thus, automatically the amount 
of notes and the deposits adjust themselves to the needs 
of trade, "since either can be had at the choice of cus- 
tomers. This outcome is one which no system of notes 



262 BANKING PROGRESS 

directly issued by a government could possibly bring 
about. 

The kind of paper made acceptable for rediscount 
under the decree of the Federal Reserve Board is all- 
important (Sec. 13). The essential point in the law is 
the distinction between mercantile and investment paper. 
It was not intended that the paper presented for redis- 
count should have been drawn to carry stocks, bonds, 
etc., or goods in warehouse held for higher prices; nor 
to aid in securing capital for fixed investment in irriga- 
tion, water-power, street-railway, manufacturing plant, 
or similar purposes. On the other hand, it was intended 
to encourage loans based directly or indirectly on the 
movement of goods from the producer to the consumer. 
Granting this general distinction, there remains the task 
of stating just what kind of paper in common use con- 
forms to the spirit of the act. 

About thirty years ago a change took place in our 
forms of paper. Previously, buyers of goods gave the 
sellers their notes for the allowed term of credit in pay- 
ment for the goods, and these notes, usually indorsed by 
the seller, were discounted at the banks. This was, 
strictly speaking, "two-name commercial paper." Un- 
der this practice, in case of goods subsidiary to further 
manufacturing processes (like ore, pig iron, steel, and 
rails) there might be several notes in the hands of the 
banks covering substantially the same goods at different 
stages of manufacture. This usage has to-day practi- 
cally disappeared. 

The introduction of trade discounts 1 made it more 
profitable for the buyer to borrow at his bank and pay 
cash for his goods. Borrowers in good standing could 
thus pay cash; while only those of poor credit created 

1 This has been fully described supra, in Chapter IV, § 6. 



THE FEDERAL RESERVE ACT 263 

"commercial paper." That is, the one-name promis- 
sory notes of borrowers in good standing at the banks 
were the best paper offered; yet it was not directly based 
on the sale of goods. The advantage of this method was 
that in effect it put trade on a cash basis. This devel- 
opment, moreover, seems to be peculiar to this country. 

On the other hand, the modern practice has the dis- 
advantage that it is not easy to know whether the bor- 
rower uses the proceeds of his loan to pay for goods, or 
whether he may use it for investment purposes; or in 
some form that is not liquid. Moreover, the acceptable 
borrower, once given a certain line of credit, usually keeps 
up to his limit by renewals, or continuous loans, without 
periodically clearing up his account by paying off his 
loans. 

In addition it should be made clear that, besides the 
notes thus described, a concern may obtain large loans 
through the agency of note-brokers, who sell them to 
banks. These are the direct, unsecured obligations of 
the borrowers. The business of the note-broker has in- 
creased phenomenally with the growth of the trade dis- 
count. If a borrower cannot obtain cash to take advan- 
tage of the trade discounts, with the aid of the note- 
brokers, his standing is obviously low. 

The Federal Reserve Board, therefore, not being able 
to alter business habits at once, must try to establish 
rules which would admit the highest grade one-name 
promissory notes, but would demand evidence that the 
loan was not used for investment, but for strictly mer- 
cantile purposes. The discounting bank must be held 
responsible for such evidence. In this way, the spirit of 
the act will be recognized, although the paper is not 
"strictly commercial." Yet there will certainly arise a 
tendency to devise forms of paper, which, while consis- 



264 BANKING PROGRESS 

tent witli the existence of trade discounts, will disclose 
more distinctly than the present promissory note the 
purpose of the borrower to use the loan for mercantile, 
and no other, purpose. 

Such being the provisions of the new act regarding 
elasticity of credit, are there any dangers of expansion? 
Fortunately the essential functions of discount are not 
hemmed in by detailed legislative prohibitions; fortu- 
nately, one must say, because discounting must always 
remain a matter of judgment, and much must be left to 
the management. Yet, on the other hand, this very 
freedom from restraint might result, under unwise man- 
agement, in inflation and danger. This is inherent in 
the very nature of banking; since under any system, good 
or bad, everything depends upon the kinds of loans 
made. And, of course, the coming of war or exceptional 
emergencies cannot be foretold. 

Even with this new act, it is not to be supposed that 
we shall never see any more crises. Crises are more or 
less inevitable, because an act of Congress cannot pre- 
vent human optimism from overtrading in goods. Thus 
no matter how perfect is the machinery of our credit 
system, it will register the spasms of trade. The essen- 
tial point to be gained by a desirable system of credit is 
that it should not aggravate the inevitable disturbances 
which will arise in emergencies of business; in the past, 
our rigid laws magnified any departure from regular 
conditions. In Europe, the banking systems are such as 
to minimize, and not magnify, trouble; which is the 
reason why Europe in recent times has been free from de- 
structive panics, while this country has abounded in them. 

The elasticity of credit implies both expansion and 
contraction according to the needs of business. Since 
any loan may be carried through by a bank giving either 



THE FEDERAL RESERVE ACT 2§5 

its own notes (or other cash) or a deposit-account, ex- 
pansion may be effected either by an overissue of notes 
or by an excessive creation of deposit-accounts. In some 
quarters, it is assumed that expansion can be regulated 
by regulating the issue of notes, or by taxing them, or 
the like. This is not true to the extent supposed. As 
a medium of exchange in paying wages, for travelling 
expenses, and for retail transactions, a certain sum of 
notes is always needed; but amounts beyond that will 
normally return to the banks. If the notes could be used 
as reserves, they would enable banks to expand loans. 
But Federal Reserve notes cannot be used as reserves by 
member banks; and here is a check on undue expansion. 
The danger, however, may exist elsewhere; these notes, 
like present national bank notes, could be used by the 
17,000 or more State institutions in their reserves. So 
much, for present purposes, as to expansion through the 
notes (which are not limited in amount). 

Those loans, it should be noted, which result in deposit- 
accounts at Federal Reserve Banks (and which are not 
drawn down by requests for notes) directly increase the 
reserves of member banks until transferred by check. 
Thus the lending power of the member bank is more 
quickly and extensively enlarged by this process than by 
the issue of notes. Herein lies the pivotal question of 
overexpansion. Passing by the question of overexpan- 
sion through the issue of notes, it is desired mainly to 
study here that arising only from the use of deposit- 
accounts and checks, because these operations are less 
understood and are more elusive. Here the possibility 
of expansion is even greater than in connection with 
notes, because the proceeds of a loan at a Reserve Bank, 
if left there, at once count as reserves, and permit another 
increase of loans. 



266 BANKING PROGRESS 

To this possibility of serious expansion, what are the 
practical checks to be found in the bill? They may 
briefly be listed as follows: 

1. Against notes the Reserve Bank must carry 40 per cent 
gold reserves; and against deposits 35 per cent reserves in 
gold or lawful money. But expansion will first develop in the 
member banks. They are not required to keep as large re- 
serves as before against deposits (carrying, of course, no re- 
serves for notes). They can make more profit with the same 
reserves by carrying more loans. Thus, there is no restriction 
here, except that of refusal of loans by the Reserve Bank. 

2. In Europe the real control over expansion is in the rate 
of discount charged to the borrower. So must it be here, if it 
is raised early and not after the expansion has arrived; but 
watch must be kept on the particular bank beginning to ex- 
pand its loans, and the treatment must be individually applied 
at the source. (See Sec. 5 of Proposed Bill, p. 172.) 

3. A still more important check resides in the provision (sec. 
13) that Reserve Banks shall rediscount only "notes, drafts, 
and bills of exchange arising out of actual commercial transac- 
tions," having a maturity of not over 90 days; although a 
limited amount of live-stock paper may have a maturity not 
exceeding six months. The final definition of all such paper is 
left to the Reserve Board. But loans secured by investment 
security cannot be rediscounted except in the case of United 
States securities. The spirit of the act, as already explained, 
forbids loans for such purposes as carrying goods in storage for 
a higher price, and should confine loans to paper based on goods 
actually sold. Just how to define such paper lays a heavy re- 
sponsibility on the Federal Board. On it will finally depend 
the kind of assets allowed to Reserve Banks. (See infra, pp. 
279 ff.) 

4. A real restriction exists in making rediscounts on only 
short-time paper; but 90 days is somewhat too long for the 
best liquidity of assets. It was asserted, however, that coun- 
try banks would gain no advantage by the new system, because 
they had little or no short-time paper. By the call of the 
Comptroller, August 9, 1913, it was disclosed that the report- 
ing national banks held loans of $3,427,055,157 maturing in 



THE FEDERAL RESERVE ACT 267 

90 days, and $2,594,351,440 maturing in a longer period; or 
58 per cent of the former, and 42 per cent of the latter. The 
6,736 country banks (outside central reserve and reserve cities) 
held $1,735,000,000 loans having a maturity of 90 days or less, 
and $1,337,000,000 maturing over 90 days. That is, even 
country banks hold more short-time than long-time paper. 
There is obviously enough paper to allow of expansion, so far 
as quantity goes. The real check must be in passing on the 
quality of the paper. 

5. The exclusion of investment paper should cut off all pos- 
sibility of expansion by stock-exchange speculation through the 
help of rediscounts at Reserve Banks. It is to be remembered, 
however, that any member bank can still loan on stock-exchange 
collateral to the extent that it does not wish for rediscounts; 
and that all state institutions not members can loan on such 
collateral. We have not, therefore, seen the end of stock 
speculation. 

6. Rediscounts at the Reserve Banks must be indorsed by 
the borrowing bank. Hence there will be some check here. 

7. Also, no member bank may loan more than 10 per cent 
of its capital and surplus to any one person or firm. This was 
later amended. (Cf. p. 279, n. 2.) 

8. A real check is found in the restriction of discounts on 
acceptances in the original act to those based on importation 
or exportation of goods; and even these shall not exceed one- 
half the paid-up capital and surplus of the borrowing member 
bank. The original omission of domestic acceptances was a 
serious handicap to the desired discount market, but for a while 
it worked toward a restriction of potential expansion. 

9. In practice the paper must pass rigid scrutiny in more 
than one step. First, it must satisfy the member bank; second, 
it must be satisfactory to the Reserve Bank; and, thirdly, if 
notes are wanted, it must pass the judgment of the Agent of 
the Reserve Board. 

10. The power of the Reserve Board to examine into the 
operations of reserve banks, and the frequent or special examina- 
tions of member banks, will give an important control over ex- 
pansion, or unsound banking, if legitimately used (sees. 21, 22). 

11. Again, it is to be noted that, in rediscounting, a large 
number of individual banks will be related to each other in 



268 BANKING PROGRESS 

a co-operative fashion. Something of an institutional char- 
acter has been introduced, and it is possible to place respon- 
sibility here and there as was never possible before. This de- 
velopment should gradually and by experience prove of im- 
portance in controlling overexpansion. 

12. Finally, if fear arises from the absence of any limit on 
note-issues, it is to be remembered that the Reserve Board can 
impose a tax upon them at their discretion, which tax will be 
added to the rate of discount to the borrower. Such a pro- 
vision should accomplish the time-honored purpose of the 
European taxes on notes passing a certain limit. To remove 
all limits on notes was right; but it was a courageous thing to 
put it in the bill, because many people think expansion is largely 
to be attributed to the quantity of issues. Trouble is less likely 
in normal times to arise from the notes than from the possible 
use of deposit-accounts following loans which demand only 
checks as a medium of exchange. 

It must be emphasized that the possibilities of undue 
expansion of credit cannot be removed by any legal 
provisions in an act. It may create machinery, but the 
speed with which it will be run will depend upon the 
judgment of the man at the throttle. Elasticity of credit 
has been given us with all its possibilities of good to 
business, together with all its possibilities for abuse. 
The whole safety of our credit fabric, therefore, rests 
upon those who pass on the paper discounted. Conse- 
quently, the success of the new system depends chiefly 
on the men selected to manage the several Reserve Banks. 
In practical operation, they are more important than 
those on the Reserve Board. 

§ 8. The new act has made possible a departure of 
very great importance in the technical methods of 
clearings and collections. It is a further development of 
economizing devices in the settlement of credits. For a 
long time the charges of clearing-houses have been a 



THE FEDERAL RESERVE ACT 269 

source of dissatisfaction. The original field of clearing- 
houses was limited to local banks in one city, but later 
it was extended somewhat by such a system as that in- 
augurated by Boston, Kansas City, and some other cities. 
In the new act larger questions of joint action over wide 
districts, or even over the whole country, are raised. 
The problem is : Can the gains of city clearing-houses and 
collections be extended to the whole territory of the 
United States? 

All the original regulations touching this matter in 
the act 1 are as follows: 

Any Federal reserve bank may receive from any of its mem- 
ber banks, and from the United States, deposits of current 
funds in lawful money, national-bank notes, Federal reserve 
notes, or checks and drafts upon solvent member banks, pay- 
able upon presentation; or, solely for exchange purposes, may 
receive from other Federal reserve banks deposits of current 
funds in lawful money, national-bank notes, or checks and 
drafts upon solvent member or other reserve banks, payable 
upon presentation (sec. 13). 

Every Federal reserve bank shall receive on deposit at par 
from member banks or from Federal reserve banks checks and 
drafts drawn upon any of its depositors, and when remitted 
by a Federal reserve bank, checks and drafts drawn by any 
depositor in any other Federal reserve bank or member bank 
upon funds to the credit of said depositor in said reserve bank 
or member bank. Nothing herein contained shall be construed 
as prohibiting a member bank from charging its actual expense 
incurred in collecting and remitting funds, or for exchange 
sold to its patrons. The Federal Reserve Board shall, by rule, 
fix the charges to be collected by the member banks from its 
patrons whose checks are cleared through the Federal reserve 
bank and the charge which may be imposed for the service of 
clearing or collection rendered by the Federal reserve bank 
(sec. 16). 

1 Later these were amended, March 3, 1915, September 7, 1916, and June 
21, 1917. 



270 BANKING PROGRESS 

In these sections, in spite of some blundering due to a 
compromise on technical questions, and from a desire to 
conciliate country banks (whose earnings are largely 
affected by charges for collections), some important ad- 
vances were made: any Federal Reserve Bank may re- 
ceive on deposit from its members or from the United 
Si & checks and drafts drawn on any solvent member 
ba: ,; "for exchange purposes" any Federal Reserve 
Bank may accept from any other Reserve Bank checks 
and drafts drawn on any solvent member bank or other 
Reserve Bank; but it is said (Sec. 16) that such items 
shall be received at par; while elsewhere certain charges 
are allowed for collecting them, which has been inter- 
preted by exchange experts as making no charge for ex- 
change, but allowing a charge for cost of service. But 
independent of "exchange purposes," any Reserve Bank 
must receive at par from member banks, or from other 
Reserve Banks, checks and drafts drawn on any mem- 
ber bank in the system, that is, without a charge for 
exchange; but yet a member bank is not to be prohibited 
from charging actual expenses for collection or exchange 
to its patrons. 

The Reserve Board is to fix the charges levied by 
member banks on patrons if these checks are cleared 
through a Reserve Bank, and also to fix the charge of the 
Reserve Bank for its cost of clearing or collection. 

Bearing directly on a future system of clearings for 
the whole country, Sec. 16 provides as follows: 

The Federal Reserve Board shall make and promulgate from 
time to time regulations governing the transfer of funds and 
charges therefor among Federal reserve banks and their branches, 
and may at its discretion exercise the functions of a clearing 
house for such Federal reserve banks, or may designate a Fed- 
eral reserve bank to exercise such functions, and may also re- 



THE FEDERAL RESERVE ACT 271 

quire each such bank to exercise the functions of a clearing 
house for its member banks. 

Since a member bank will have reserves in its Reserve 
Bank, a balance in the clearings by a Reserve Bank against 
a member bank can be directly charged against the ac- 
count of said member bank, and all charges for collec- 
tion would be avoided. Any cost for handling these 
clearings could be charged by the Reserve Bank against 
member banks. A saving over the present methods is 
thus possible. How far a wide-reaching system of clear- 
ings may be developed, in spite of the extensive clerical 
service required, depends largely on organization and 
future dispositions. It is possible that the present city 
clearing-houses may be superseded. 

There is, under the new law, a discrimination in favor 
of a check drawn on any member bank: in the future it 
should be received at par in any part of the country 
equally with New York or Chicago exchange. There- 
fore all past methods of drawing exchange are to a certain 
extent likely to be upset. Certainly checks on non- 
member banks will be discriminated against, and they 
must go through the old process of collection, which will 
not be so quick or so inexpensive as that of member banks. 
Competition of non-member banks may lower the cost, 
or checks on non-member banks may be collected by de- 
positing checks of non-member banks with member banks. 

The use of checks drawn by individuals on their local 
banks to make payments even of small sums in any 
part of the country lies at the bottom of the extensive 
system of collections and clearings in the United States. 
In Europe this burden is largely escaped by being thrown 
on remittances through banks. The new act clinches 
the present habit, and makes it permanent, by supply- 
ing the means of continuing it. 



272 BANKING PROGRESS 

§ 9. It had been hoped by the friends of the National 
Monetary Commission Plan to introduce in this country 
a discount market such as exists in the financial centres 
of Europe. A discount market obviously means a mar- 
ket where certain kinds of paper can be sold at any time. 
To suit paper for such a market it must have universal 
acceptability by having a maker whose credit is accepted 
in any market. Established institutions, rather than 
private persons, are likely to be thus recognized. Prom- 
issory notes, the usual paper discounted in this coun- 
try, are the promises of individuals or firms, and therefore 
have no wide recognition. The process of making an 
acceptance is as follows: The person wishing credits 
will go to a large mercantile house, or bank, and ask the 
privilege of drawing a bill on it, falling due at a date in 
the future, which will be accepted by them on presen- 
tation. The house, or bank, writes across the face of 
the bill the word "accepted," with the date and its sig- 
nature. A promise to pay in the future to a bank and 
"accepted" by it has the security and recognition of 
the acceptor. Hence, the use of acceptances has been 
urged as necessary to the existence of a discount market 
in this country. 

Hitherto, acceptances had not been permitted by law 
to national banks. Under the new act our banks were 
allowed to accept, as follows: 

Any member bank may accept drafts or bills of exchange 
drawn upon it and growing out of transactions involving the 
importation or exportation of goods having not more than six 
months sight to run; but no bank shall accept such bills to 
an amount equal at any time in the aggregate to more than 
one-half its paid-up capital stock and surplus (sec. 13) , l 

1 Amended, March 3, 1915, to equal the stock and surplus. 



THE FEDERAL RESERVE ACT 273 

The limitation of acceptances to transactions in for- 
eign trade, and the omission of authority to make ac- 
ceptances based on domestic transactions, obviously 
limited the supply of paper which could be offered in a 
general discount market. The reason for such omission 
was the fear of undesirable expansion, if the right to ac- 
cept were given free rein. In all cases the customer ask- 
ing for the acceptance agrees to provide the accepting 
bank with funds to cover the acceptance on or before 
the day it falls due. The acceptor only lends his credit, 
to the customer, and does not advance any cash. Hence 
in accepting a bill drawn on it a bank would not create 
a liability by a deposit-account against which it must 
carry reserves; and in this country the temptation to 
accept beyond moderation might have been too strong 
to be resisted, if a curb were not introduced. As the law 
stood, a limited use of acceptances was permitted, which 
might be extended by later legislation, provided tradi- 
tions of safety were thereafter established. Moreover, 
it is doubtful if bills of exchange drawn on the actual 
movement of goods, or bills drawn on banks, in order 
to provide acceptances could be extended to such an 
extent in this country as to supplant the promissory note. 

Besides the general market for acceptances, the new 
act permitted Federal Reserve Banks to deal in them: 

Any Federal reserve bank may discount acceptances which 
are based on the importation or exportation of goods and which 
have a maturity at time of discount of not more than three 
months, and indorsed by at least one member bank. The 
amount of acceptances so discounted shall at no time exceed 
one-half the paid-up capital stock and surplus of the bank for 
which the rediscounts are made (sec. 13). 

If our acceptances based on cotton, for instance, were 
made salable in London, or on the Continent, they would 



274 BANKING PROGRESS 

in effect provide a means of bringing in foreign capital 
to finance the movement of our crop. This would be an 
obvious advantage. 

In other respects, the purpose of selling acceptances in 
a discount market would be to change the assets of the 
holder into cash. So far as member banks wish to do 
this, they may obtain the end in another way, by redis- 
counting paper with a Federal Reserve Rank; but such 
operations are limited by the resources of capital at the 
disposal of the Reserve Banks. 

§ 10. So far as Americans are engaged in foreign trade, 
or are located in foreign countries, they labor under some 
disadvantage, if they are obliged to do their business 
through foreign banking institutions. In international 
relations, and in granting of loans, the trade of any one 
country is usually favored by the institutions owned by 
the citizens of that country. Our business men are not 
so well known that they can obtain loans from foreign 
banking-houses in Buenos Aires or Hongkong as favorably 
as those who have been long known to their commercial 
and banking institutions. A young country must fight 
for its recognition in trade; and it needs the support 
abroad of its own powerful banking institutions. 

Moreover, American bankers were obliged to share 
commissions with foreign bankers on an immense amount 
of * international trade originating with us. Formerly 
American drafts and bills, if sent abroad in payment of 
imports from Europe, could not be sold in the discount 
markets of Europe, because the American firms were 
not sufficiently well known. 

As soon as our foreign trade warrants it, and as soon 
as we have capital enough so that a surplus can be em- 
ployed out of the country, foreign banking branches, if 



THE FEDERAL RESERVE ACT 275 

profitable, will come into being under the provisions of 
the new act (Sec. 25). Such branches are permitted to 
national banks having a capital and surplus of $1,000,000 
or more, subject to examination by the Federal Reserve 
Board, and provided the accounts of each branch are 
kept separately from those of any other branch. 1 

§ 11. As regards the independent treasury system, 
the act has, unfortunately, brought no definite removal 
of the possibilities of past evils. Not only were more 
important matters attracting chief attention in the bill, 
but also there was an evident purpose in the administra- 
tion to retain in its hands as much power as possible over 
the money market. Hence the act was only permissive 
in the provision (Sec. 15) for the deposit of government 
funds with the banks of the new system: 

The moneys held in the general fund of the Treasury, except 
the five per centum fund for the redemption of outstanding 
national-bank notes and the funds provided in this act for the 
redemption of Federal Reserve notes, may, upon the direction 
of the Secretary of the Treasury, be deposited in Federal Re- 
serve Banks, which banks, when required by the Secretary of 
the Treasury, shall act as fiscal agents of the United States; 
and the revenues of the Government or any part thereof may 
be deposited in such banks, and disbursements may be made 
by checks drawn against such deposits. 

No public funds of the Philippine Islands, or of the postal 
savings, or any Government funds shall be deposited in the 
continental United States in any bank not belonging to the 
system established by this act ; Provided, however, that nothing 
in this act shall be construed to deny the right of the Secretary 
of the Treasury to use member banks as depositories. 

Nevertheless, there is so general and subconscious an 
understanding of the undesirability of withdrawing gov- 

1 Amended, September 7, 1916, sec. 14 (e). 



276 BANKING PROGRESS 

ernment funds from the money market that public opin- 
ion would doubtless enforce a rational policy on the 
Treasury at all times; but the act leaves the avoidance 
of evil solely to the personal will of the secretary. 

§ 12. It should be remembered, however, that it 
was possible under this act to require membership only 
of national banks. At the time of its passage there were 
more than twice as many banks out of the system as in 
it. 1 Therefore, the relations of the national to the State 
banks and trust companies were important and had to 
be reckoned with. The liabilities of the national banks 
to these outside institutions amounted to over $1,200,- 
000,000; while there was due from them to national 
banks a sum nearly half as large as from other national 
banks. The desirability of creating a situation such 
that the State banks should find it to their interest vol- 
untarily to join the system was early recognized. The 
provisions of Sec. 9 did not bring this about. The greater 
freedom from examinations and reports and the less 
stringent requirements regarding reserves and kinds of 
business done enjoyed by State banks gave them cer- 
tain advantages in remaining out of the system. More- 
over, existing provisions of State laws hindered the ac- 
ceptance of the new act by State banks. On the other 
hand, the rise of a great emergency, like war, would make 
a disunited banking system a source of danger where 
unity of regulation and action might be a source of 
strength to the credit of the country. In a time of stress 
many State banks must undoubtedly rely for aid directly 
or indirectly on the Reserve Banks. Sooner or later — 
as in the early struggle after 1864 between the new na- 

1 By 1917 only about one-half the banking resources of the country were in- 
cluded in the Federal Reserve system. 



THE FEDERAL RESERVE ACT 277 

tional banks and the State banks — one or the other must 
inevitably take the lead. It is certain that the logic of 
events will bring the larger part of the State banks into 
the Federal Reserve system. 

There are many other matters which might be touched 
upon in connection with the new law; but within our 
limits it has been possible to discuss only the chief topics 
selected. There are unfortunate provisions in the act, 
such as those in Sec. 24, permitting loans on farm lands 
by banks that create demand-liabilities. They should 
not tie up their resources in an unliquid form like loans 
on land. But the sum and substance of the whole act 
is so remarkably good, that the combined support of 
both bankers and the public is certain to be given to it 
to the end that it may work smoothly and bring a long- 
desired reform to an expectant nation. 



CHAPTER XI 

WORKING OF THE FEDERAL RESERVE ACT 

§ 1. The inauguration of a new banking system, in- 
volving many departures from established methods, in- 
evitably necessitated interpretations and adjustments 
largely administrative in character. Practical experi- 
ence also showed the need of amendments to the law. 
Beyond these in importance came the test of the essen- 
tial principles on which the act was based, particularly 
when tried out in the exceptional conditions produced by 
the European War. No banking system could have 
been subjected to a harder test; and it would be strange 
if it had not disclosed some weaknesses either of policy 
or of structure. 

Although the act was passed seven months before the 
outbreak of the war, it was nearly eleven months before 
the system began operations (November 16, 1914). For 
this delay there are none but political excuses. It was 
not until August 10, 1914, that the Federal Reserve Board 
took the oath of office. The panic of 1914 forced the 
organization that should have been completed months 
before. The subconscious belief in the new system al- 
ready enacted served at the best to produce only a psy- 
chological steadying effect in the summer of 1914. * 

The Reserve Bank Organization Committee had al- 
ready located the twelve districts, designated the seat for 
each Reserve Bank, and secured the election of their di- 
rectors. There early arose the need of defining the kinds 
of paper to be discounted by the Reserve Banks for their 

1 See Laughlin, Credit of the Nations, pp. 297-306, 350-353, for the situation 
during the panic of 1914. 

278 



WORKING OF FEDERAL RESERVE ACT 279 

members. After a series of orders, a final regulation of 
the Federal Reserve Board was issued June 22, 1917, 1 
superseding previous ones, thus defining the paper which 
could be rediscounted under Sec. 13 : 

Notes, drafts, or bills of exchange, of not more than 
ninety days; made for agricultural (six months), indus- 
trial, or commercial purposes, and not for carrying securi- 
ties (except those of the United States); the aggregate 
of any one borrower not to exceed 10 per cent 2 of the 
bank's capital and surplus (except bills drawn against 
actually existing values); indorsed by a member bank, 
and the proceeds of which are not to be used for fixed 
investments, such as land, building, or machinery. 

A promissory note is defined as an unconditional promise, 
in writing, signed by the maker, to pay in the United 
States, at a fixed or determinable future time, a sum 
certain in dollars to order or to bearer. 

A draft or bill of exchange is an unconditional order in 
writing, addressed by one person to another other than 
a banker, signed by the person giving it, requiring the 
person to whom it is addressed to pay, in the United 
States, at a fixed and determinable future time, a sum 
certain in dollars to the order of a specified person. 

A trade acceptance is a draft or bill of exchange drawn 
by the seller on the purchaser of goods sold and accepted 
by such purchaser. 3 

Agricultural paper, which has a maturity of not more 
than six months, is a note, draft, bill of exchange, or 
trade acceptance, the proceeds of which have been used, 

1 Bulletin, July, 1917, pp. 539-543. 

2 To further the placing of government bonds this restriction was raised un- 
der certain conditions to 20 per cent by the act of March 3, 1919. Bulletin, 
March, 1919, p. 229. 

3 For terms of sale in the principal industries, see Bulletin, December, 1919, 
p. 1129, and later issues. 



280 BANKING PROGRESS 

or are to be used, for agricultural purposes, including the 
breeding, raising, fattening, or marketing of live stock. 

Commodity paper 1 is a note, draft, bill of exchange, or 
trade acceptance, accompanied and secured by shipping 
documents or by a warehouse, terminal, or other similar 
receipt covering approved and readily marketable, non- 
perishable staples, properly insured (September 3, 1915). 

A banker's acceptance is a draft, or bill of exchange, of 
which the acceptor is a bank or trust company, or a firm, 
person, company, or corporation engaged in the business 
of granting banker's acceptance credits. 

Paper of the above descriptions, properly eligible, may 
be discounted by any Federal Reserve Bank for any of 
its member banks. 

Another form of paper produced far-reaching effects 
during the war. By act of September 7, 1916, a Federal 
Reserve Bank was allowed to loan directly to a member 
bank on its fifteen-day promissory note, secured by such 
notes, drafts, bills of exchange, or bankers' acceptances 
as are eligible for rediscount or for purchase by Federal 
Reserve Banks, or by the deposit or pledge of bonds or 
notes of the United States. 2 The use of this device 
helped to expand loans on collateral of our government's 
war obligations to prodigious sums. 

Under former banking habits, rediscounting of its 
customers' paper by a bank had been regarded as a mark 
of weakness. Under the new act that came to be the 
usual resort of member banks wishing to enlarge reserves. 
At first, however, there had been a release of old reserves, 
the beginning of an inflow of gold during 1915, and, in 
a tide of general prosperity, little need for rediscounting. 
There was little to indicate the coming of unprecedented 

1 Merged with other paper, cf. p. 284, n. 1. 

2 April 5, 1918, bonds or notes of the War Finance Corporation were included. 



WORKING OF FEDERAL RESERVE ACT 281 

burdens after we entered the war. In providing perhaps 
$30,000,000 of discounts by the end of 1915 there was no 
hint of the record figure of over $8,000,000,000 during 
October, 1919. 

Much attention was given to the introduction of ac- 
ceptances among the short-time paper which could be 
presented to the Federal Reserve Banks for rediscount 
or bought in the open market. It was a matter of slow 
education in a community to which that form of paper 
was new. 1 In our foreign trade acceptances were more 
or less familiar, and as a cautious beginning they were 
made available for discount in the original act. In the 
first year or so there was a feeling that the system should 
be coddled to enable it to earn dividends. In the original 
act, acceptances could not be rediscounted for a member 
bank to an amount exceeding one-half its capital and 
surplus. Very soon the Federal Reserve Board was au- 
thorized, under certain conditions, to permit such ac- 
ceptances to 100 per cent of their capital and surplus. 2 
Later, domestic acceptances were made available, pro- 
vided the member bank did not accept to more than 50 
per cent of its capital and surplus. 3 

1 For an account of trade paper and the usual character of commercial paper 
before the Federal Reserve Act, see supra, Chapter IV, Sec. 6. 

2 By act of March 3, 1915, Section 13 was amended by the addition of the 
following words: "except by authority of the Federal Reserve Board, under 
such general regulations as said Board may prescribe, but not to exceed the 
capital stock and surplus of such bank, and such regulations shall apply to all 
banks alike regardless of the amount of capital stock and surplus." As a con- 
sequence, the board publishes lists of banks to whom it is permitted to accept 
up to 100 per cent of capital and surplus, under Circular No. 12, series of 1915, 
dated April 2, 1915 (Bulletin, May, 1915, p. 46). The restriction to 100 per 
cent refers not only to the limit to which the member bank may accept, but 
also to the limit of discounts of such acceptances by a Federal Reserve Bank. 

Also, acceptances to any one firm were limited to 10 per cent of capital and 
surplus, unless the bank is secured either by attached documents or by some 
other actual security growing out of the same transaction as the acceptance. 

3 Under the act of September 7, 1916, a Federal Reserve Bank was permitted 
to discount banker's domestic acceptances, provided shipping documents are 



282 BANKING PROGRESS 

Bankers' acceptances were also encouraged, in the 
desire to develop a discount market at home and abroad. 
By the end of 1915 dealings in them had risen to $100,- 
000,000. Such acceptances were taken by the Federal 
Reserve Banks mainly by purchase in the open market 
(together with government bonds and municipal war- 
rants). In the discounts of the Federal Reserve Banks, 
however, bankers' acceptances have not yet played any 
important part, rising only to about $2,000,000 in one 
month (November, 1919). But, November 30, 1919, 
the Reserve Banks had purchased in the open market 
$495,330,000 of bank acceptances, of which $347,852,000 
had been accepted by member banks. 

The progress in developing a discount market in this 
country through the introduction and use of acceptances 
has been very marked of late. Various organizations 
have urged their adoption. Finally it has become gen- 
erally understood how great an advantage it is to change 
dead trade accounts into live assets by adopting trade 
acceptances. The buyer of goods is no worse off if, 
instead of being a debtor to the seller on a book account, 
he has accepted a bill drawn on him for a certain date. 
There is the additional advantage for him that he is 
taught to pay such debts when due and not to depend 
on a running account which is never settled. 

It is to be noted that enterprising State banks of New 
York began the use of acceptances for financing exports 
to Europe as early as August, 1914. After the inaugura- 
tion, November 16, 1914, of the Federal Reserve system, 
national banks also began accepting bills. Since Feb- 
ruary 12, 1915, the Federal Reserve Bank of New York 

attached at the time of acceptance, or which are secured at the time of accep- 
tance by a warehouse receipt or such other document conveying or securing 
title covering readily marketable staples. See Regulation A, series of 1917, 
June 22, 1917, Bulletin, July, 1917, p. 540. For the act, see Bulletin, September, 
1916, pp. 439-442. 



WORKING OF FEDERAL RESERVE ACT 283 

has been buying acceptances. Probably the most effec- 
tive measure for bringing about an extensive use of ac- 
ceptances was the action of the New York Clearing- 
House, August 1, 1918, ruling that notes and acceptances 
could be sent through the morning clearings on the day 
of maturity. Acceptances are thus treated as if they 
were checks. 1 Finally, it has come about that institu- 
tions have been formed here, after the manner of the 
London Discount Houses, for the announced purpose of 
dealing in acceptances and foreign paper. 2 The dis- 
count market has practically arrived. 

Apart from discounting for member banks (Sec. 13), 
the Reserve Banks had an important function intrusted 
to them in the power (Sec. 14) to engage in open-market 
operations. Large and important consequences might 
follow from this power, especially as affecting market 
rates of interest, and holdings of gold exchange or public 
securities. The banks might be able, in periods when 
there were few demands for discounts from member banks, 
to steady the rate of interest. Also the Reserve Banks 
could thus invest idle funds in paper of various kinds 
other than that indorsed by a member bank, and in se- 
curities, which would increase their earnings over and 
beyond ordinary discounting. By these operations pur- 
chases were made of bankers' acceptances on a consider- 
able scale. The regulations for the actual practice of 
the system were dated December 4, 1915. 3 

1 See Bulletin, September, 1918, pp. 819-821. The client should place the 
accepting bank in funds on the day of maturity either by deposit of clearing- 
house funds one day prior to maturity; or by cash or check on the Federal Re- 
serve Bank of New York on day of maturity; or by debit to client's bank ac- 
count against funds cleared prior to such date. 

2 The Union Discount Corporation was directed to cotton acceptances. 
Several other houses, however, have been organized for general acceptance 
operations. / 

3 Circular No. 20, series of 1915. See also Special Instructions, No. 2, dated 
September 15, 1916. Bulletin, October, 1916, pp. 529-534. 



284 BANKING PROGRESS 

In regard to rates, it was obviously the policy from 
the beginning to establish low and uniform rates. There 
was a desire to have the Reserve Banks made serviceable. 
Looking back, there is a question whether rates were not 
fixed at a level which tended to too great expansion of 
loans, especially those afterward made for carrying gov- 
ernment obligations. At the close of 1915 the rates on 
bankers' acceptances were little over 2 per cent; trade 
acceptances about 33^; 90-day paper at 4 and 4j^; 
commodity paper 1 at 3 and 3^. Such rates must have 
encouraged rediscounts. When we entered the European 
War in 1917, however, a change of importance took place. 
Preferential rates were established in favor of notes se- 
cured by government certificates or bonds. 2 As low as 
3 per cent was granted for 15-day paper of this sort; 
and in general it was intended that the rate should corre- 
spond with the rate paid by the bonds. Such a policy 
may have been justified by the necessity of selling bonds; 
but, whatever the reason, it was a great departure from 
the fundamental principles of the Federal Reserve Act. 
It favored, instead of discriminated against, loans based 
on securities as collateral. That an enormous change 
should take place in the character of the liquid holdings 
of the system was certain. Consequently, it was inevi- 
table that difficulties should arise, and that at the end 
of 1919 the rate on loans secured by war obligations should 
be raised to 5H> per cent in order to force their liquida- 
tion, no matter how painful the process might be. It 
is a question whether the rates should not have been 
raised on this kind of paper long before. The rise in the 
rate of discount should be used as a preventive rather 

1 Commodity rates were designed to appeal to the growers of cotton and 
grain. December 3, 1917, this kind of paper was merged with other com- 
mercial paper. Annual Report, 1917, pp. 11, 103. 

2 See Bulletin, June, 1917, p. 425. 



WORKING OF FEDERAL RESERVE ACT 285 

than as a cure. In December, 1917, while rates in gen- 
eral were raised, a preferential rate was still given to war 
paper. 

One form of paper, however, was anomalous and had 
no place in the system. The treatment of farm paper 
was governed more by political than by legitimate bank- 
ing considerations. In the original act (Sec. 13) agricul- 
tural paper, having a maturity not exceeding six months, 
was comprised in the provisions maintaining the funda- 
mental liquidity of paper to be discounted by a Reserve 
Bank. 1 An inconsistent provision, however, was wrongly 
introduced in Sec. 24, allowing country banks to loan 
on farm lands for five years to 50 per cent of the value 
of the land; but such loans were limited to 25 per cent 
of the bank's capital and surplus, or to one-third of its 
time-deposits. 2 This was contrary to the spirit of the 
act. Such loans should have been made only by banks 
such as were later organized separately under the Federal 
Land Bank Act. 3 But an amendment to the Federal 
Reserve Act, September 7, 1916, went further in the 
wrong direction by admitting loans on real estate as 
distinguished from those on farm land. 

§ 2. The original act required that the capital should 
be paid in gold, but that the reserves might be paid in 
lawful money, or even that one-half might be in the form 
of rediscounted paper. It was also understood that 
banks might draw on their city correspondents for funds 
for this purpose. Before the opening of the system, 

1 Rediscounts of six months' paper were limited to 198 per cent of the sub- 
scribed capital of a Reserve Bank. Bulletin, September, 1916, p. 443, and Regul. 
G, Fourth Annual Report, p. 175. 

2 Regulation I, series of 1915, Bulletin, May, 1915, p. 43. Cf. Annual 
Report, 1916, p. 163. 

3 Enacted July, 1916, and organized March, 1917. 



286 



BANKING PROGRESS 



however, the Reserve Board 1 urged each bank to make 
payment in its own gold and from its own vaults. Since 
reserves could be had by rediscounting paper, there was 
no reason for member banks to hoard gold. The result 
appeared in the first published account, which is interest- 
ing for comparison with recent expanded accounts: 



Nov. 20, 1914 


[In millions] 




Liabilities 


Assets 


Capital 


...$ 18.1 


Loans 

Investments 

Other resources 


$ 5.6 

.1 


Deposits 

Federal Reserve notes . . . 


... 227.8 
... 1.2 






Gold 

Lawful money 

Total cash 


.$204.9 
. 36.5 


241.4 






$247.1 


$247.1 



The reduction in the reserves to be carried by member 
banks under the new act (Sec. 19) came when the old 
national banks were below the legal reserves in the panic 
of 1914. There was, therefore, a very considerable re- 
lease of reserves, and an easement of the market rate, 
when the new system went into operation. The act set 
a transition period of three years, ending November 16, 
1917, within which reserves were to be partly withdrawn 
from the vaults of member banks and gradually placed 
with the Reserve Banks. At the end of this period about 
one-third of the required reserves were to remain in the 
vaults of country and reserve city banks. There was a 
fear of disturbance during the process. In the act of 
August 15, 1914, some slight changes were made in the 
fractions to be held at home and in the Reserve Banks. 2 

1 Circular No. 10, October 28, 1914. First Annual Report, p. 167. 

2 Also a State bank, becoming a member, might for a time, under certain 
conditions, keep its reserves with a non-member bank. But no member bank 
should, without consent, obtain discounts from a Reserve Bank for a non- 
member bank. See First Annual Report, p. 45. 



WORKING OF FEDERAL RESERVE ACT 287 

By November 26, 1915, member banks had without dif- 
ficulty paid into the Reserve Banks $321,068,000 of gold. 
The State banks showed little disposition to join the 
new system, and several States lowered the legal reserves 
for their banks. In such cases the general reserve system 
was weakened to allow State banks to compete with 
member banks now supported by the ability to gain re- 
serves at any moment by rediscounts. In the act of 
September 7, 1916, member banks were permitted to 
carry in Reserve Banks any reserves then required to be 
kept in their own vaults. At the same time efforts were 
made, in 1916, to hasten the final movement of reserves 
to the Reserve Banks and not to wait until November 
16, 1917. Because of the abnormal imports of gold due 
to excessively large war exports, it was believed the 
member banks could advance their payments of reserves 
and also strengthen the gold holdings of the Reserve 
Banks. The act of June 21, 1917 (Sec. 10), finally car- 
ried this policy into effect, and at the same time lowered 
the percentage of reserves. Section 19 of the Federal 
Reserve Act was so amended 1 as to provide for the im- 
mediate transfer of all reserves to the Federal Reserve 
Banks; and the amounts of required reserve were fixed 
as follows: 



Demand- 
deposits 
Per cent 



Time- 
deposits 
Per cent 



Country banks 

Reserve city banks 2 

Central reserve city banks 



7 
10 
13 



Thereafter member banks were not required to carry 
any reserves in their own vaults; but the new amend- 

1 See Federal Reserve Bulletin, July, 1917, pp. 508, 517. The weekly state* 
ment of June 23, 1917, appears in the revised form. 
1 For the revised list of reserve cities, see Annual Report, 1917, p. 30. 



288 BANKING PROGRESS 

ments had the effect of obliging the banks to increase 
their former holdings with the Reserve Banks. 

To this point we have been concerned with reserves 
kept for deposits. But we are already confronted with 
a shortcoming in the Federal Reserve system through 
the confusion of notes and deposits. The two are un- 
scientifically mixed together. The reserves in gold be- 
hind the notes ought to be kept distinct from any regula- 
tions for reserves behind the deposits. In practice, it 
was desired to encourage the deposit of gold for reserve 
notes even to 100 per cent, so that they would serve the 
same purpose as gold certificates. Unfortunately the 
act is structurally weak at this point. Since only 40 
per cent in gold is required behind the notes, the addi- 
tional gold could be transferred to reserves behind de- 
posits, in exchange for commercial paper. Thus prac- 
tically a new basis for reserves in gold was established 
in June, 1917. 1 As time went on and the system was 
strained in the effort to carry enormous loans based on 
war and other obligations, the consequent rise of the de- 
posit item due to discounts directly affected the percent- 
age of reserves behind both notes and deposits. But 1 
the ratio computed on both notes and deposits was con- 
fusing and gave no true understanding of the situation. 

§ 3. There had always existed some antipathy be- 
tween national banks and those chartered by the States. 
Yet from the passage of the Federal Reserve Act it was 
the evident purpose to unify all the banks of the country. 
State requirements had been less severe regarding re- 
serves, examinations, etc.; and State banks had been 
granted many auxiliary privileges — low reserves against 
savings-accounts, powers to act as executor, trustee, ad- 

* See Bulletin, July, 1917, pp. 503-504. 



WORKING OF FEDERAL RESERVE ACT 289 

ministrator, registrar, etc., not permitted to national 
banks — at the same time that they carried on the bank- 
ing functions of deposit and discount. Thus large banks 
had grown up outside the national banking system. 
From the start, overtures were made to State banks to 
join the new system, but to little avail. Of course, a 
State bank on entering must conform to requirements 
established for all member banks; but the laws of some 
States afforded difficulties. There was strenuous ob- 
jection by the smaller banks to the loss on collections 
involved in going into the new system with its clearings 
at par; but also to new examinations and intricate state- 
ments as well as to the loss of interest on balances, if 
reserves were to be transferred to the Reserve Banks. 

In the main, State banks and trust companies had 
grown up in competition with the national banks, until 
they were far greater in number, because of forms of 
business not allowed to national banks. If, therefore, 
it were to be made easy for State banks to become mem- 
bers, it was obvious that national banks should not be 
cut off from those forms of business formerly confined to 
State banks. This was granted in the original act, 1 but 
later (September 26, 1918) guarded by requiring separate 
accounts for trust funds and the like. Nevertheless, 
these provisions were regarded as an intrusion into the 
private preserves of State banks; and their constitu- 
tionality was even denied. 2 

The dealings of directors and attorneys with a bank 
in Section 22 of the original act caused difficulty. In 
order to prevent illegitimate operations by which officials 

1 Sec. 9 (K) . To grant by special permit to national banks applying therefor, 
when not in contravention of State or local law, the right to act as trustee, 
executor, administrator, or registrar of stocks and bonds under such rules and 
regulations as the said board may prescribe. 

2 See Annual Report, 1915, p. 12. 



290 BANKING PROGRESS 

could make a profit in bringing business to the bank, the 
act had practically prohibited directors from doing busi- 
ness with the bank. 1 The act of September 26, 1918, 
while providing against improper transactions, permitted 
dealings in the regular course of business between a 
member bank and its directors, or a firm to which they 
belonged, with certain publicity of details. 

It soon became clear that State banks could earn 
more 2 by joining the new system and transferring reserves 
to Reserve Banks, because a large part of them could be 
invested in a form which would serve as safe secondary 
reserves. Moreover, Section 9 was so amended by the 
act of June £1, 1917, as to allow a State bank or trust 
company to retain its full charter and statutory rights, 
with all corporate powers granted it by the State, and 
yet become a member of the new system. 3 Changes in 
State laws also removed obstacles. Finally, all objections 
seem to have been removed. Even then many State 
banks remained out. No marked change, however, ap- 
peared until the necessities of the war brought the 
stimulus sufficient to cause a general movement into 
the new system. The appeal of President Wilson, Oc- 
tober 13, 1917, for a complete mobilization of the bank- 
ing and credit resources of the United States, because 
of our entry into the European War, was met by 
a patriotic response from State banks. 4 The largest 

1 See Bulletin, June, 1918, pp. 513-515. 

2 See Bulletin, July, 1918, pp. 615-622. 

3 It was not subject to examination by the comptroller. Also examinations 
by State authorities might be accepted, if approved by the Federal Reserve 
Board. See Bulletin, July, 1917, p. 512. It could withdraw on six months' 
notice, and was unaffected by Sec. 8 of the Clayton Act, relating to interlock- 
ing directorates. 

4 Yet as late as June, 1918, there were about 8,000 eligible State institutions 
with a capital of about $695,000,000 and surplus of $425,000,000 out of the 
system. At the end of 1919 there were 1,181, with capital of $421,000,000 and 
surplus of $447,000,000 in the system. 



WORKING OF FEDERAL RESERVE ACT 291 

State banks are as a rule now in the Federal Reserve 
system. 

§ 4. The obvious intent of the Federal Reserve Act 
(Sections 13, 16) to take over the clearing of checks 
raised a question of serious difficulty, not only because 
it warred against established customs but against the 
close relations of banks with their city correspondents. 
Moreover, the system could control only member banks. 
The stumbling-block lay in the matter of charges for 
collection and exchange. In the past the reserves kept 
with correspondents had been drawn upon for exchange, 
and banks had made a charge for collection. 

March 4, 1915, the Reserve Board provided for the 
voluntary clearing of checks within each district. 1 It 
did not supersede existing local clearing-houses, nor did 
it cover the clearing of checks between banks in different 
districts, nor the settlement of balances between Federal 
Reserve Banks. Meanwhile, October 4, 1915, checks 
on the Richmond Reserve Bank were by arrangement 
received at par by the New York Reserve Bank. Early 
in December, 1914, the St. Louis and Kansas City Re- 
serve Banks had permission to apply a required system 
to their members; but, when the voluntary system was 
later introduced, 80 per cent of the St. Louis district and 
all of the Kansas City district continued their member- 
ship. The loss of exchange business and the opposition 
to having a check which a bank had not seen charged 
against its account at a Reserve Bank worked against 
the success of the plan. 

In April, 1916, a more comprehensive plan was elabo- 
rated to go into effect July 15, 1916. Each Reserve Bank 
was required to exercise the functions of a clearing-house 

1 See Bulletin, May, 1915, p. 6, and June, 1915, p. 78. 



292 BANKING PROGRESS 

for its members on interdistrict checks. No member 
bank was required to use it; and members could still keep 
accounts with correspondents; but they must pay at par 
all checks drawn on them and presented at their own coun- 
ters. Federal Banks presented checks by mail, but did 
not debit items until returns came back from each bank. 1 
Checks on State banks that could be collected at par 
were received. Subject to a small service charge (not 
over 2 cents per item) par collections by the end of 
1916 extended to over 15,000 banks. It was an advan- 
tage to a bank as against a competitor that its checks 
were receivable at par. On July 15, 1916, the Federal 
Reserve Bank of Boston took over the work of the Boston 
Clearing-House, and collected checks on all banks (in- 
cluding State banks) in its district without charge (ex- 
cept a service charge of 0.9 cent per item). 

The act of September 7, 1916, and of June 21, 1917, 
amended Section 13 of the Federal Reserve Act, in order 
to extend clearings to those non-member banks which 
maintain with a Reserve Bank a balance sufficient to 
cover items presented for exchange or collection. Mem- 
ber banks were allowed to charge for collection, but not 
over 10 cents per $100; but no charge could be made 
against a Reserve Bank. 2 

When reserves were no longer (after June 21, 1917) 
held in other banks nor in a bank's vaults, there was no 
reason why exchange should not be drawn on Reserve 
Banks, nor was there anything to restrict clearings by 
member banks through the new system except the matter 

1 See Bulletin, June, 1916, p. 262; July, 1916, p. 312. Regulation J, series 
of 1916 (Bulletin, October, 1916, p. 542), superseded former ones. 

2 An opinion was rendered by Attorney-General Gregory, March 21, 1918, 
excluding non-member banks from limitations as to charges. See Bulletin, 
May, 1918, pp. 367-371. See also Annual Report, 1917, p. 23, on the Hard- 
wick Amendment. 



WORKING OF FEDERAL RESERVE ACT 293 

of charges for the expense incurred. Country banks had 
been accustomed to make a charge for exchange in re- 
mitting for checks drawn on themselves, but by the new 
system they must remit at par. The power to fix charges 
remains in the hands of the Federal Reserve Board, 
but there has been much opposition to the compensation 
granted. 1 Great efforts, nevertheless, have been made 
to have all the banks in a State join the par list. At the 
end of 1919 there was a daily average of clearings of over 
$600,000,000 by 9,055 member banks and 15,851 non- 
member banks on the par list. 2 But as yet the system 
is not universal. 

A system of transfer drafts also has been inaugurated, 
by which a draft of a member bank on its Reserve Bank 
may be paid without time allowance or deduction at any 
other Reserve Bank. Such a method requires the exist- 
ence of the Gold Settlement Fund at Washington as a 
means of clearing between the twelve Reserve Banks. 
This fund was established as early as May 27, 1915. 3 By 
this means the title to funds in one district can be trans- 
ferred to another without the actual movement of money. 
Each Reserve Bank is required to keep in this fund with 
the Treasury of the United States a balance of not less 
than $1,000,000. Reports are made on each Wednesday 
evening by telegraph for the "checker-board, " and weekly 
statements are issued. The first withdrawal was made 
July 14, 1915, by a telegram from the Federal Reserve 
Bank of Chicago, filed at 10.30 a. m., and at 2.30 p. M. 

1 See the Report of the "Committee of Five" of the American Bankers' 
Association, Bulletin, October, 1918, p. 962. Cf. Bulletin, May, 1918, p. 371; 
September, 1918, p. 819. 

2 Bulletin, January, 1920, p. 94. The map showed the Southern States as a 
whole not on the par list. Cf. Bulletin, December, 1919, pp. 1113-1114. For 
meaning of "par," see Bulletin, July, 1916, p. 310. 

3 Regulation L, series 1915, Bulletin, June, 1915, p. 78. Second Annual Re- 
port, pp. 77-79. 



294 BANKING PROGRESS 

of the same day the assistant treasurer of the United 
States at Chicago was ready to make payment to the 
Chicago Bank of the $2,000,000 requested. 1 In Sep- 
tember, 1915, transfers in the Gold Settlement Fund 
were authorized between each federal reserve agent and 
Federal Reserve Banks. 2 The Federal Reserve Agents' 
Fund consisted of gold deposited for safe-keeping with the 
Federal Reserve Board and held by them to reduce the 
liability of Reserve Banks against Federal Reserve notes 
outstanding. At first, gold order-certificates on the 
treasurer in denominations of $10,000 were used, but 
have been discontinued. The total volume of clearings 
through this fund during 1918 amounted to $26,962,- 
946,500, the large figure being chiefly due to sales of gov- 
ernment obligations. But the transfers also prevented 
the old shifting of funds for crop-moving purposes. 

The success of the Gold Settlement Fund in saving 
shipments of gold within one large country has suggested 
the possibility of an international gold exchange fund for 
commercial transactions between nations. It seems clear, 
however, that the depreciation of European money will 
for many years postpone any such plan. 3 

§ 5. The Federal Reserve system began operations 
in 1914 when we owed a large sum of gold to Europe. 
Our phenomenal exports of goods, however, from 1915 
entirely reversed the movement of gold. As a consequence 
our banking and currency system, by an unequalled stroke 
of good fortune, and in spite of the expansion due to the 
war, has been throughout maintained on a basis of un- 
equivocal convertibility into gold. The exceptional im- 

1 Bulletin, August, 1915, p. 183. 
- Bulletin, October, 1915, p. 303. 

3 See Fifth Annual Report, p. 35. As concerns South America and the western 
hemisphere, see Bulletin, March, 1919, p. 198. 



WORKING OF FEDERAL RESERVE ACT 295 

ports of gold and the concentration of reserves brought 
about by the new banking system united to raise the 
gold reserves of the Reserve Banks at the close of 1919 
to $2,078.4 millions. It is estimated that $300,000,000 
of hoarded gold have been returned to the banks since 
the armistice. 1 To prevent gold escaping to enemy 
countries, since September 7, 1917, an embargo was placed 
on the exportation of gold. 2 The original act did not pro- 
vide for the direct issue of Federal Reserve notes against 
gold deposited with Reserve Banks. For a time the Re- 
serve Banks deposited surplus gold with reserve agents, 
and, by withdrawing the pledged paper, thereby reduced 
their liability for notes outstanding. Thus at the close 
of 1916, of $300,110,000 notes, only $17,588,000 were se- 
cured by commercial paper. But by the act of June 21, 
1917, it was proposed to make the note function as a gold 
certificate. Unfortunately a 40 per cent reserve of gold 
does not make a gold certificate. 3 As we shall see later 
this was a means of unduly expanding credit, because the 
excess gold was transferred to reserves for deposits. At 
the time, however, it served to augment the gold holdings 
of the Reserve Banks. 

With over $2,000,000,000 in gold, 4 with an amazing 
excess of exports of goods, a creditor to other nations, 
thereby possessing the claim through the foreign ex- 
changes over funds in other countries, the position of 
the United States was almost incredibly strong as re- 
gards the gold basis. It is now the only country which 
can offer a free market for gold. And yet in spite of such 

1 Bulletin, July, 1919, p. 616. 

2 Removed June 26, 1919, with a few exceptions affecting Russia. See Bul- 
letin, September, 1919, p. 853. 

3 The jubilation on this matter (Fourth Annual Report, p. 12) is scarcely jus- 
tified. 

4 Exclusive of gold in the Treasury and national banks. For the gold reserves 
of the world, see Bulletin, February, 1919, p. 140. 



296 BANKING PROGRESS 

good fortune we have a situation in 1920 in which we 
have actually reached the limit of our banking credit, 
due to loans based on unliquid war obligations, and to 
the pressure for loans in other directions. 

§ 6. In foreign operations the original act (Section 14) 
allowed Reserve Banks to establish foreign agencies, to deal 
in cable transfers and eligible paper with foreign banks; 
and also (Section 25) permitted our national banks, 
having a capital and surplus of $1,000,000, to establish 
branches in foreign countries. The limitations of these 
provisions led to demands for more latitude. The secre- 
tary of the treasury opposed the creation of independent 
foreign banks, and urged the entrance of the Federal 
Reserve Banks into Latin America through joint agencies; 
but the board was adverse to locking up its reserve funds 
in loans of the character available in those countries. 1 
The act of September 7, 1916, then permitted a bank to 
subscribe not exceeding 10 per cent of its capital and 
surplus to the stock of banks chartered in the United 
States to carry on foreign banking under some regulation 
by the Federal Reserve Board. 2 Finally, greater freedom 
was allowed by the Edge Act 3 of December 24, 1919, by 
which federal corporations, under the approval of the 
Federal Reserve Board, were authorized in foreign deal- 
ings to carry on the functions of discount and deposit, 
and even to issue notes. They may also be asked to serve 
as fiscal agencies for the Treasury. 

Under Section 14 the Federal Reserve Bank of New 

1 See Bulletin, October, 1915, p. 313, and November, 1915, p. 348. 

3 At the end of 1918 the National City Bank of New York had established 
more than a score of foreign branches, and the First National Bank of Boston 
one in Buenos Aires. See Bulletin, October, 1918, p. 942, and November, 1918, 
p. 1079. In addition five banking corporations had qualified. Fifth Annual 
Report, p. 59. For list at end of 1919, see Bulletin, December, 1919, p. 1154. 

8 See Bulletin, January, 1920, pp. 56-59. 



WORKING OF FEDERAL RESERVE ACT 297 

York was authorized, December 25, 1916, to appoint as 
its foreign agent the Bank of England. Accordingly, 
June 7, 1917, obligations in London amounting to $50,- 
000,000, due to Americans, were paid to the Bank of 
England. The Reserve Bank of New York assumed the 
obligation to American holders of the paper (properly 
distributed to other Reserve Banks), but the gold, "ear- 
marked" by the Bank of England, became a part of the 
reserves of our Reserve Banks under the item "Gold 
held with foreign agencies." Likewise, February 28, 

1917, the Reserve Bank of New York established an 
agency with the Banque de France at Paris. 1 In June, 

1918, foreign exchange with Italy was made subject to 
the approval of the representative of the Italian Institute 
of Exchange. 2 

§ 7. No other event can compare in importance and 
in its effect on the Federal Reserve system with the 
European War. Not only did it touch every function 
of banking, but — most significant of all — it put to the 
test and brought out all structural weakness. In Europe 
the tremendous strain on banking systems showed the 
inferior quality of the French and German to the English. 3 
Yet in the United States, in the matter of placing gov- 
ernment loans, we tended to follow Continental rather 
than English experience as regards borrowing directly 
from the banks. In Great Britain and in the United 
States alone is there the same method of using checks 
drawn on deposits as a means of payment, instead of 
using bank-notes as on the Continent. And yet we 
tended away from the very genius of English and Ameri- 

1 See Bulletin, January, 1917, p. 5,^and March, 1917, p. 175. 

2 Bulletin, July, 1918, p. 594. 

? See Laughlin, Credit of the Nations, chaps. Ill, IV, and V. 



298 BANKING PROGRESS 

can practice in being led to depend largely upon issues 
of notes. This tendency has been seen in preceding 
chapters. In the war our banking policy was dominated 
by a political rather than by a banking intelligence. 

In Great Britain the Bank of England is used strictly 
as a fiscal agent to whom revenues are paid and by whom 
expenditures are met. The bank does not itself sub- 
scribe to great loans; it acts as an agent only, except so 
far as the Treasury secures aid by ways and means credits 
at the bank. On November 23, 1915, the secretary of 
the treasury (under the permissive authority in Section 
15 of the act) appointed the Federal Reserve Banks as 
depositaries and fiscal agents of the United States, 1 to 
take effect January 1, 1916. On that date government 
funds in national banks were transferred to the Reserve 
Banks. 2 But, after we entered the war, on the offer of 
the First Liberty Loan, the Reserve Banks were desig- 
nated, May 14, 1917,. as fiscal agents on loan subscrip- 
tions. This was the beginning of operations that in- 
volved the banks in very large transactions. 

In anticipation of the bond-issue, short-term certifi- 
cates of indebtedness were offered to the banks and the 
public. The proceeds from the latter, turned over to 
the Reserve Banks for the government account, were 
at once paid out by the Treasury for war supplies, or 
to the Allies, who spent the sums in this country. These 
expenditures immediately returned to the banks as pri- 
vate deposits. Thus funds subscribed to the Treasury 
came back before the bond-issue was offered, and pre- 
vented a convergence of payments on any fixed date. 
When the long-term bonds later appeared for subscrip- 

1 See Bulletin, December, 1915, p. 395. 

2 Already $15,000,000 had been transferred to the Reserve Banks of Rich- 
mond, Atlanta, and Dallas ($14,000,000 through the Gold Settlement Fund) 
to aid in the movement of cotton. 



WORKING OF FEDERAL RESERVE ACT 299 

tion, the volume of outstanding certificates, which were 
exchangeable for bonds at par, were used in payment 
of the bonds chiefly by the banks; or as the government 
paid off the certificates the proceeds were given for bonds. 
Customers of banks, subscribing for bonds, would pay 
either by cash, by checks drawn on their deposit-accounts, 
or by the proceeds from loans got from the banks secured 
by the bonds as collateral. When member banks remitted 
to Federal Reserve Banks for bonds taken, they drew 
down their cash assets, or their reserves in the Federal 
Reserve Banks. But these reserves could be replenished 
by a rediscount of customer's paper secured by war ob- 
ligations (departing thus from commercial paper, as re- 
quired by the true principle of the act) at the Federal 
Reserve Bank, or by the direct 15-day note of member 
banks supported by bonds or certificates. 1 The outcome 
of this credit operation — while not necessarily increasing 
the demand of the public for more notes as a medium of 
exchange — was the existence of a large amount of gov- 
ernment obligations in the assets of the banking system 
to protect demand-liabilities of the banks either in the 
form of deposits or notes. At the end of 1919 the total 
of these undigested securities rediscounted at the Re- 
serve Banks amounted to $1,510,364,000. 2 Thus the 
banks themselves became deeply involved in the fiscal 
operations of the government. In passing from com- 
mercial paper to war obligations as a basis for rediscount 
the way was opened for an extension of credit limited 

1 This policy was encouraged by a preferential rate on such loans, as well as 
on those to customers of banks. Member banks were also allowed to redis- 
count thus for non-member banks. Bulletin, June, 1917, pp. 425-426. Banks 
and trust companies subscribing to more than $100,000 bonds were considered 
as depositaries, and could pay by granting a credit on their books to the Trea- 
sury. See also Fifth Annual Report, p. 79, for the act of April 4, 1918. 

2 The war paper held by all banks was $2,495,000,000. Bulletin, October, 
1919, p. 943. 



300 BANKING PROGRESS 

only by the needs of the Treasury. It is not forgotten, 
of course, that the original act (Sec. 14) permitted the 
rediscount of paper based on bonds and notes of the United 
States; but the context shows it could never have con- 
templated the use of such paper on the great scale ac- 
tually permitted during the war. Also the banks came 
to own very large amounts of bonds as investments. Here 
was a great danger; for as one vast loan followed after 
another, the mass of unliquid securities was enormously 
increased, since the bonds were salable only at prices 
steadily declining below par. In such ways our prac- 
tice differed from that of the Bank of England. 

A measure, having a tendency to expand credit on 
collateral not acceptable to a Reserve Bank, was enacted 
April 5, 1918, by which the War Finance Corporation 1 
was created with a capital of $500,000,000 provided by 
the government. The Federal Reserve Banks were for- 
bidden to discount paper supported by stocks or bonds, 
although, as we have just seen, this policy (not the law) 
was departed from in making loans based on our govern- 
ment securities. But this corporation was authorized to 
discount for banks which granted loans to firms (whose 
operations were contributory to the prosecution of the 
war) the promissory notes of the banks secured by the 
collateral offered by the firm to the banks. Also, loans 
could be made directly to such firms under certain re- 
strictions. Such loans might run for five years. The 
corporation could also issue bonds. By this act the Re- 
serve Banks were allowed to discount the direct obliga- 
tions of member banks secured by such bonds of the 
corporation and to rediscount eligible paper secured by 

1 For the text of the act, see Bulletin, April, 1918, pp. 301-306. For its 
Annual Report, see Bulletin, January, 1919, p. 28. This measure was in some 
ways similar to the resort in Germany to Darleknskassen, which granted loans 
that would not be accepted by the Reichsbank. 



WORKING OF FEDERAL RESERVE ACT 301 

such bonds and indorsed by a member bank (Section 13). 
Banks, having made loans to war industries not accep- 
table to Reserve Banks, could thus get advances from the 
War Finance Corporation. 1 Later the corporation was 
permitted to aid exporting firms. 2 

In passing to a matter of general importance, it is to 
be remembered that under the original act (Section 15) 
the independent treasury system was not abolished. It 
was only provided that the secretary of the treasury 
may deposit government funds with the Federal Reserve 
Banks. 3 It was at his discretion alone that funds were 
sent to Southern Reserve Banks in September, 1915, to 
help move cotton. It should be noted, also, that since 
the Reserve Banks have been made fiscal agents there 
is no reason for retaining the old sub treasuries now be- 
come obsolete. 4 

§ 8. The original act of December 23, 1913, extended 
the life of the Aldrich-Vreeland Act 5 one year from June 
30, 1914, to June 30, 1915, and reduced the tax on its 
notes to 3 per cent per annum for the first three months, 
with an additional one-half per cent for each month until 
6 per cent was reached. In the panic of 1914 6 not only 
were clearing-house certificates to the maximum of $109,- 

1 The Capital Issues Committee under this act passed on the question whether 
issues of securities were compatible with the public interest. It ceased to act 
December 31, 1918, and was dissolved by proclamation August 30, 1919. 

2 See Liberty Loan Act, March 3, 1919, Sec. 9. Bulletin, March, 1919, pp. 227- 
228. Cf. also an amendment widening such loans, Bulletin, October, 1919, 
p. 966. 

3 Cf. supra, p. 275. See Bulletin, October, 1915, p. 301, for the first deposits. 
Also in connection with the special deposit of proceeds of bond sales, under 
the fiscal act of September 24, 1917, as amended April 4, 1918, see Bulletin, 
June, 1918, p. 494. 

4 See the Report of the Bureau of Efficiency, January 26, 1918 (H. R. Doc, 
No. 867). Bulletin, March, 1918, pp. 172-178. 

6 See supra, Chapter IV. 

6 See Laughlin, Credit of the Nations, pp. 299-305. 



302 BANKING PROGRESS 

185,000 issued, but the demand for an emergency cur- 
rency led to an amendment of the act of 1908. The act 
of August 4, 1914, removed the prerequisite to note- 
issues of 40 per cent of bond-secured notes, raised the 
total issue to 125 per cent of capital and surplus, and 
abolished the limit of $500,000,000 to the total circula- 
tion. After these amendments Aldrich-Vreeland notes 
were issued for the first time to a total of $381,530,000, 
but were all retired by June 30, 1915. If the Federal 
Reserve Banks had been in operation, such issues need 
not have been made. 

The purpose of the Federal Reserve Act was the even- 
tual substitution of all bond-secured national bank notes 
by Federal Reserve notes (Section 18). As bonds of 
the United States were withdrawn under the act from 
the security for the old national bank notes, and were 
taken over by the Reserve Banks, these institutions were 
allowed the option of depositing these bonds with the 
comptroller and obtaining "Federal Reserve Bank notes/' 
on the same basis as old national bank notes. 1 When 
the period arrived, December 23, 1915, at which national 
banks could begin to dispose of the bonds used to secure 
their notes, the total amount offered in the first quarter 
was $16,041,700 as against one-fourth of the $25,000,000 
yearly purchases allowed. But meanwhile the Reserve 
Banks had been buying government bonds in the open 
market, which the Federal Reserve Board regarded as 
an offset against any allotment from those offered through 
the treasurer. In all but one instance the purchases in 

1 Since they are the obligations of a Federal Reserve Bank the words "na- 
tional currency" are engraved on the top margin of the face of the note and 
"Federal Reserve bank note" on the bottom margin of the same side of the 
note. But they differ as to security and origin from the Federal Reserve notes, 
which are obligations of the United States, and which have the words "Federal 
Reserve note" engraved on their face. 



WORKING OF FEDERAL RESERVE ACT 303 

the open market exceeded the quota to be allotted. Hence 
the Reserve Banks were not required to buy any of those 
offered under Section 18. 

The conversion of 2 per cents (having the circulation 
privilege), however, went on into one-year gold notes 
and 3 per cent 30-year gold bonds (without the circula- 
tion privilege) to the amount of $30,000,000 for 1916— 
half and half of each. The same amount was converted 
for 1917. The conversion of bonds having the circula- 
tion privilege will thus tend to reduce the amount of old 
national bank notes outstanding. But very little use 
was at first made by the Reserve Banks of Federal Re- 
serve Bank notes. Toward the end of 1917 their amount 
was only $12,758,885.* Under the Pittman Act, April 
23, 1918, retiring silver certificates for silver melted and 
exported, Federal Reserve Bank notes of any denomina- 
tion were authorized to take their place. Accordingly, 
these notes were increased by the close of 1919 to $254,- 
933,000. 2 

The old national bank notes remained in the circula- 
tion very slightly changed in amount. 3 In 1914 there 
were outstanding $750,671,899, and at the end of October, 
1919, $722,394,325. Of the bonds bearing the circula- 
tion privilege $63,945,460 of Spanish -American War 3 
per cent bonds matured August 1, 1918; but by the end 
of 1919 bonds bearing the circulation privilege totalled 
$793,115,530. The demands for circulation were strong 
and the bonds remained practically unchanged during 
the stress of war. 

A most important new element, however, was intro- 
duced by the Federal Reserve notes. As a consequence 

1 Bulletin, January, 1918, p. 18. 

2 Fin. RpL, 1919, p. 102. 

3 To help relieve the shortage of small notes, national bank notes of less de- 
nomination than $5 were allowed by the act of October 5, 1917. 



304 BANKING PROGRESS 

of a remarkable increase in loans at the Reserve Banks, 
mainly due to borrowings secured by government war 
obligations, there must be a corresponding increase of 
demand-liabilities either in the form of deposits or notes. 
The increase of Federal Reserve notes was the most signifi- 
cant feature of this period. It represented, moreover, a 
policy. There was a natural reason for encouraging the 
substitution^ of Reserve notes for the old national bank 
notes, but there was very little reduction in the latter. 
The encouragement to the increase of Reserve notes must 
rather be ascribed to the law itself and their unfortunately 
too direct relation to the increase of loans. That is why 
the emphasis on the separation of the issues from loans 
and deposits in Chapter IX (Section 8) seems to be of 
present and future importance. By the time we entered 
the war the Reserve notes had already grown (March, 
1917) to $336,269,000; but the phenomenal increase to 
$3,057,646,000 in actual circulation by the end of 1919 
is obviously connected with conditions produced by the 
war. 

It was the general policy to gather into the Reserve 
Banks all the gold of the country; and the issue of Reserve 
notes whenever they could be exchanged for gold was a 
part of that policy. Early in 1917 x optimistic views were 
held as to the possible increase of Reserve notes as emer- 
gency-issues up to $1,000,000,000 (a sum overpassed, in 
fact, by November of that year). The main emphasis 
seems to have been placed on the new status given to 
Reserve notes by the act of June 21, 1917. Before that 
date, Reserve notes could be issued only on the deposit 
of eligible paper; but this act authorized their issue di- 
rectly for gold or gold certificates; and, under the pro- 

1 Bulletin, March, 1917, p. 155. 



WORKING OF FEDERAL RESERVE ACT 305 

vision for a 40 per cent gold reserve behind the notes, a 
proviso was introduced: 

That, when the Federal reserve agent holds gold or gold 
certificates as collateral for Federal reserve notes issued to 
the bank such gold or gold certificates shall be counted as part 
of the gold reserve which such bank is required to maintain 
against its Federal reserve notes in actual circulation. 

That is, after gold was obtained by federal reserve agents 
in direct exchange for notes, only 40 per cent of such 
gold need be regarded as legal gold reserve behind the 
notes, and the remainder could be regarded as surplus 
gold or as protection against deposits (after substituting 
eligible paper for all beyond 40 per cent of gold as pro- 
tection to the notes). 1 This plan to collect gold was also 
furthered by not requiring member banks to carry there- 
after any reserves in their own vaults. In addition, Re- 
serve notes could be issued upon the security of 15-day 
notes of member banks secured not merely by eligible 
paper, but by government obligations. It can be seen 
that the policy to encourage the issue of Reserve notes 
was furthered by all these provisions. Although a 35 
per cent reserve is held for deposits in gold or lawful 
money, it is quite clear that the holding of one gold re- 
serve equally for the two demand-liabilities, notes and 
deposits, shifting from one to the other, is a reversion 
from the well-recognized policy of a separate reserve for 
notes back to the older and supposedly obsolete system 
of the old United States Banks and the State banks in 
the early part of the last century. Nor does there seem 
to be any justification, especially m the very great ex- 
pansion of notes, for this retrogression. At the Bank of 
England, beyond a stratum of £18% millions of consols, 

1 Bulletin, July, 1917, pp. 503-504, 506-507, 510, 515. 



306 BANKING PROGRESS 

there is a pound of gold for every pound note. Since 
1838 and under the national banking system also it has 
been American policy to separate reserves for notes from 
reserves for deposits. 

It is not easy to account satisfactorily for the extraor- 
dinary increase in the Reserve notes. Before their time 
our currency (national bank notes, greenbacks, etc.) was 
inelastic. It is possible that when a really elastic cur- 
rency was created in the Reserve notes there was revealed 
a larger demand than was suspected for a medium of 
exchange. So far as this is true there was no inflation; 
for, as immediate redemption in gold is maintained, any 
excess would be returned at once. It may be interesting 
to note what calls could be made for these new notes. 
As gold moved into the Reserve Banks, Reserve notes 
would take their place in the hands of the public. In 
fact, the gold holdings of the Reserve Banks amounted 
(December 26, 1919) to two-thirds of the notes in cir- 
culation. And in the year from July 1, 1918, the gold 
certificates in circulation diminished by $287,991, 138. 1 
Moreover, non-member banks no doubt carry Reserve 
notes in their reserves. As they were permitted to borrow 
on security of war obligations through member banks they 
could thereby increase their lending power by calling for 
Reserve notes. Thus the desire to sell bonds must have 
led to an increase of notes and to a considerable expansion 
of loans by banks outside of the reserve system. Again, 
it is probable that during the war the amounts absorbed 
by the public in circulation were greatly increased. 
Those who did not deposit in banks came into possession 
of more money than ever before. Wages had been greatly 
increased, and the workers retained currency in large 
sums. An increase of only $50 per capita in these 

1 Finance Report, 1919, p. 553. 



WORKING OF FEDERAL RESERVE ACT 307 

classes would account for almost the whole increase 
in the Reserve notes. In addition, the rise of prices from 
100 to 219 would require more than twice as much money 
to be passed from hand to hand for the same quantity 
of goods as were exchanged in 1914. It is also stated 
that much of our currency (almost the only one in the 
world equal in value to gold) was drawn off to Canada, 
Mexico, Cuba, Philippine Islands, Hawaii, Porto Rico, 
Santo Domingo, Haiti, Honduras, and Panama. 1 If 
these notes were redundant it would be quickly shown 
by the redemptions; but there has been little evidence 
of a redundancy as yet. The increase in Reserve notes 2 
at various dates may be stated as follows: 



[In millions] 



Reserve notes 



All money out- 
side Treasury 
and Federal Re- 
serve system 



April 4, 1917 

June 27, 1917 

November 21, 1917 

April 18, 1918 

August 22, 1918... 
October 17, 1918.. 
October 10, 1919. . 
December 26, 1919 . 



$ 376.5 
508.8 
1,015.8 
1,514.2 
2,032.8 
2,502.4 
2,741.6 
3,057.6 



$4,100.9 

4,isi!i 

4,266.8 
4,449.8 
4,925.9 
4,958.9 
5,172.2 



It will thus be seen that from our entrance into the war, 
the Reserve notes increased far more than the total money 
in circulation; that from November, 1917, the increase 
of Reserve notes was over a billion dollars more than the 
total. It is likely that not all of this increase was needed 
as a medium of exchange. 3 

1 Fin. Report, 1919, p. 20. 

2 Bulletin, November, 1919, p. 1046, and January, 1920, p. 109. 

8 The discretionary charge of a rate of interest on the notes to force retire- 
ment was never used. Bulletin, June, 1916, p. 273. A separate rate on notes 
issued under the War Finance Corporation Act could be charged. 



308 BANKING PROGRESS 

§ 9. Whatever the system of banking, in whatever 
country, the test of its management and the soundness of 
its condition is to be found in the character of its assets. 
By the very nature of a commercial bank, as distinct 
from a mortgage company or a savings-bank, its im- 
mediate liabilities — its demand deposits and notes — de- 
pend for their payment on the assets being liquid and 
quickly convertible into cash. That is the reason why 
short-term paper is essential to liquidity. The cash re- 
serves are only a stop-gap. If loans were not based on 
transactions whose proceeds would liquidate the loans 
at their maturity, cash reserves, no matter how large, 
would soon be used up. When that happens, even with 
great but unliquid assets, a bank must suspend payment 
and go into liquidation. The difference between success 
and failure lies in the ability to maintain liquid assets. 
How far the Federal Reserve system has travelled on 
this dangerous road it is our duty to report. 

An expansion of credit is not to be tested by the quan- 
tity of its demand-liabilities — its deposits and its notes — 
but by the liquidity of its assets in the loan item. No 
matter how large these two forms of immediate liability, 
for which cash can be demanded at any moment, if loans 
are being constantly, day by day, paid off and new ones 
of the same quality taking their place, in totals as large 
as their liabilities, then all is safe. The Federal Reserve 
Board, in a different way, defined inflation "as the proc- 
ess of making additions to credits not based upon a com- 
mensurate increase in the production of goods." 1 If this 
means that loans made on commercial paper directly re- 
lated to the production and sale of staple goods could not 
lead to inflation, then it would follow that loans made on 

1 Bulletin, July, 1919, p. 614. 



WORKING OF FEDERAL RESERVE ACT 309 

unliquid assets would inevitably lead to inflation. That 
there has been an expansion of credit, practically result- 
ing in drawing down our ratio of reserves to demand- 
liabilities to the danger-point, there can be no doubt. 
Nor is the cause of this expansion in any way obscure. 
Whether we could have escaped it or not, the fact is that, 
as a result of mixing banking with the fiscal operations of 
the Treasury, the banks of the country have become 
heavily loaded with more or less unliquid assets in the 
form of war obligations and war paper, amounting in 
June, 1919, to $6.5 billions. 1 The amount of war paper, 
or loans on collateral of war obligations, was about $2.5 
billions. That this very large increase of loans was fol- 
lowed by an increase of notes and deposits goes without 
saying. Nor can these demand-liabilities be reduced 
until the loans have been paid off. 

As early as the summer of 1917, after the first war loan 
and the passage of the act of June 21, 1917, there were 
suggestions as to undue expansion. There was already 
a relative increase of war paper and a relative decrease 
of commercial paper. The extension of acceptances was 
side-tracked. It was assumed that the loans to buyers 
of bonds would be temporary, and rather light-heartedly 
war paper was encouraged by being given a preferential 
rate of discount even over good commercial paper. 2 In 
truth, the reverse ought to have been the policy, so that 
saving and the liquidation of war paper would have been 
forced, especially if other government loans were certain 
to follow. Toward the end of 1917 the board clearly 
saw the danger from unliquid assets. Already the financ- 
ing of British short-term notes, made the basis for ac- 

1 Bulletin, October, 1919, p. 943. 

2 Bulletin, June, 1917, pp. 425, 430, and October, 1918, p. 922. 



310 BANKING PROGRESS 

ceptances, but to be successively renewed, had been 
tabooed as creating unliquid assets. Also, the same 
method for domestic corporations was opposed, 1 the 
board saying: 

The system must use every effort to maintain its liquid 
character and . . . commercial paper regarded as eligible for 
discount must be of a kind calculated to provide its own means 
of liquidation. Admission of long-term obligations, or obliga- 
tions short-term in form only, . . . was regarded as unques- 
tionably opening an avenue of danger to the system. 

But yet, obligations of our government were admitted 
as a basis of loans, even though it produced unliquid as- 
sets. In the year 1918, with its succession of enormous 
government loans, the expansion rapidly proceeded. In 
February renewals by member banks were noted. The 
securities owned by the banks increased markedly, the 
national banks alone having added by the end of 1917 
$910,000,000. By October, 1918, the total investments 
of Reserve Banks had risen to $2,295,000,000, and of 
member banks to $14,022,000,000. As a consequence, 
deposit-liabilities of Reserve Banks rose to $1,580,000,000, 
and of member banks to $11,731,000,000. 2 Meanwhile 
the percentage of cash reserves to deposits and notes which 
had been over 80 in the summer of 1917, fell to nearly 50 3 
by the end of 1918, and at the end of 1919 to 44.8 (while 
at the Reserve Bank of New York it was about 40 in No- 
vember, 1919). Since then it has fallen even lower. The 
whole situation of the Reserve Banks may be seen from 
the account of December 26, 1919: 

1 Bulletin, December, 1917, p. 922. Cf. ibid., 1918, p. 249. 

2 Bulletin, November, 1918, p. 1048. 

8 See table, Bulletin, February, 1919, p. 137. 



WORKING OF FEDERAL RESERVE ACT 311 

[In millions] 



Liabilities 

Capital paid in $ 87.3 

Surplus 81 . 1 

Deposits: 

Government deposits.. . . 72.3 

Due to members (re- 
serve account) $1,786.9 

Deferred availability 
items 822.7 

Other deposits 97.7 

Total gross deposits 2,779 . 6 

Notes in circulation: 

Federal Reserve notes 3,057.6 

Federal Reserve Bank notes 261 . 

Other liabilities 58.8 



Resources 

Discounts: 
Secured by government 

war obligations $1,510.4 

All other 684.5 

Bills bought open market. . 585 . 2 

Government bonds 26 . 8 

Victory notes .1 

U. S. certificates of indebt- 
edness 273 .5 

Total earning assets $8,080.5 

Cash: 
Gold and gold certificates 229 . 4 
Gold Settlement Funds . . 352 . 8 
Gold with foreign agen- 
cies 134.3 

Gold with reserve agents 1 ,240 . 

Gold Redemption Fund . 121 . 9 

Total gold reserves 2,078 .4 

Legal-tender notes, silver, 

etc 57.1 

Total eash 2,135 . 5 

Uncollected items 1,075 . 1 

5 per cent Redemption Fund (Fed- 
eral Reserve Bank notes) IS . 2 

Bank premises 13 .0 

All other resources 8.1 

Total resources $6,325 .4 



Total liabilities $6,325 . 4 



When examining the condition 1 of member banks, 
however, at the end of 1919 we find the expansion of 
loans not so much in carrying government securities as 
in other paper: 

[In millions] 



Loans secured by U. S. obligations $1,022 .7 

Loans secured by other than U. S. stocks and bonds 3,270.5 

All other loans and investments 9,339 . 9 

Total U. S. securities owned 1,981 .7 

Total loans and investments $15,614 . 8 



x Bulletin, January, 1920, pp. 103-104. Figures are not given by which a 
comparison can be made with conditions before we entered the war, April, 
1917. 



312 BANKING PROGRESS 

Against these assets there were liabilities: 

[In millions] 



Net demand-deposits $11,195 . 1 

Time-deposits 2,293 .4 

Government deposits 647.9 

$14,136.4 

Reserve balance with Federal Reserve Bank 1,316 . 9 

Cash in vault 403 . 5 



Total reserves $1,720 



In this account the character of "all other loans" is far 
more important than that of the war paper. Moreover, 
of bills rediscounted with Reserve Banks, only $306.3 
millions were secured by government war obligations. 
Of bills payable with Reserve Banks, $841.4 millions were 
thus secured. It seems to be clear that the expansion 
of credit was by no means confined to war paper. 

§ 10. It would have been surprising if any banking 
system could have been created which would not have 
shown some defects of structure under the phenomenal 
and unparalleled strains of the European War. Nor is 
it to be expected that no mistakes of policy should have 
been made by the management. 

First of all the lessons to be learned from our unusual 
experience is that there is need of better control over 
undue expansion of credit. For a time the official publi- 
cations of the board showed a naive jubilation at the un- 
limited banking power of the system. This policy had 
a tendency to encourage a resort to the system for pur- 
poses inconsistent with the fundamental purposes of the 
act. No banking system can look forward to an inex- 
haustible fund of credit. Limitations are set by the 
amount of available banking capital, the thrift of the 
community by which alone additional capital can be 



WORKING OF FEDERAL RESERVE ACT 313 

supplied, and by the turnover of staple goods which is 
dependent on the efficiency of the productive processes 
in the various industries. It was amazing that, in spite 
of other demands, our people could supply in taxes and 
loans to the government the means to cover the cost of 
the war (about $34,000,000,000). When the need of 
credit from the banks was called upon in placing enor- 
mous loans, it was obvious that continuing industrial 
needs must also be cared for. By the end of 1919 the 
combined demands of both these factors had practically 
reached the limits of our banking power. Even though 
commercial needs were restricted it was properly urged 
that necessary operations must be hindered unless assets 
in the form of war paper were taken up by the public. 
This was only an appeal for more capital through new 
saving by subscribers to loans. 

It is a question whether the inevitable limitations of 
credit were sufficiently foreseen and duly provided for. 
As we have noted, the fear of inflation was present in 
1917 and frequently stated. But what was done to pre- 
vent it? The time-honored remedy was the increase in 
the charge for loans. The board asserted that it was not 
possible to raise the rate of discount while government 
loans were being placed. It is not certain, however, that 
a higher rate on war paper would have so reduced the 
patriotic feeling of the country that the loans would not 
have been subscribed for. Subscriptions in general would 
hardly have been antagonized by, so relatively small a 
matter as the rate to borrowers on the part of the loans 
which required bank credit. For war paper the prefer- 
ential rate was of questionable wisdom. It encouraged 
borrowing on the security of bonds, as compared with 
liquid commercial paper. Under general principles war 
paper ought to have been charged a higher rate. The 



314 BANKING PROGRESS 

application of the break on expansion of credit by a higher 
rate of discount should have come before a serious emer- 
gency had arisen. In fact, any real attempt to raise 
rates did not appear before November, 1919, when the 
limits to credit were close before us. A more courageous 
and far-sighted policy would have been better. 

It would be well to consider also whether it had not 
been better to rule against the tendency to expansion at 
its source by automatically adding a sliding scale of com- 
missions to the rate of discount charged a member bank 
as its rediscounts rose relatively to its capital. This was 
proposed but passed by when the act was adopted. 1 

Moreover, the concentration of reserves, especially of 
gold, had been heralded as a mighty power for good. 
The convergence of gold into the hands of the Reserve 
Banks was accomplished; but it created a dangerous 
overconfidence. Even an abnormally high fund of gold 
is limited in its power. Already the deposits and notes, 
as the result of expansion, are so large that the reserve 
requirements leave no great margin of "free gold." A 
change in international trade which would call for gold 
exports would be serious. A further growth of business 
would be met by the fact that, outside of the sums in 
the Reserve Banks, there is no considerable amount of 
gold in the country to be drawn upon. Our exports may 
not for long continue to give us control of foreign gold, 
even if it were available. 

A much more important matter, and one that is struc- 
tural, arises from the provisions of the act regarding notes. 
Unhappily, the act shows the influence of an attitude of 
mind leaning toward Continental rather than toward 
British or American banking traditions. To be sure, 

1 See supra, p. 172. A bill is before Congress (April, 1920) to accomplish 
this very purpose. 



WORKING OF FEDERAL RESERVE ACT 315 

there has always been with us, since greenback days, an 
inclination in some quarters to believe in the potency of 
note-issues in times of emergency. This has already been 
noted in connection with our panic of 1907. 1 But the 
whole spirit of our banking progress in recent years had 
been toward the organization of credit and the placing of 
our media of exchange on an elastic, automatic basis in- 
dependent of fiscal operations. To give the Federal Re- 
serve notes safety and elasticity by admitting commer- 
cial paper as a protection (with an additional gold reserve 
of 40 per cent) did not imply any necessity for confusing 
the quantity of note-issues with fiscal operations, or with 
general banking operations carried on by the check-and- 
deposit system, so well established here and in Great 
Britain. Since 1844 an expansion of British credit at the 
banking department of the Bank of England has gone on 
independently of the security of the bank-notes put out 
by the issue department. During the war Bank of Eng- 
land notes were not expanded by the fiscal operations of 
the Treasury. The one great blunder was the issue of 
currency notes (government paper) as a means of bor- 
rowing, the only measure which has seriously threatened 
the British gold standard. On the other hand, on the 
Continent, and especially in France and Germany — 
where notes, hot checks drawn on deposits, form the 
main medium of exchange — government borrowings led 
directly to an enlargement of bank-notes. The outcome 
of this system in Germany has been a submergence of 
the note-issues under fiscal borrowings from the Reichs- 
bank and the depreciation of the notes almost to the 
level of our old colonial currency. Under the Federal 
Reserve Act we have, unfortunately, inclined to Con- 
tinental precedents, and not fully separated our Reserve 

1 See supra, Chapters III, IV, and VII. 



316 BANKING PROGRESS 

notes — now our chief currency — from the fiscal opera- 
tions of the Treasury and the purely credit functions of 
discount and deposit. 

As already mentioned — oblivious to our own character- 
istic American development away from the methods in 
existence before 1838 by which notes were mixed up with 
credit operations — we seem to have drifted back to what 
is practically one reserve of gold for both demand-liabili- 
ties, notes and deposits. 1 When we entered the war, Re- 
serve Bank statements gave a separate percentage of the 
reserve for notes and for deposits, but by the beginning 
of 1918, when the percentage of reserves had fallen from 
above 80 to 65, the percentage is given for the two com- 
bined liabilities. Therein lies a tendency to an unde- 
sirable end. When the 40 per cent reserve in gold for 
notes is subtracted from cash no considerable excess re- 
mains above the 35 per cent for deposits. That is, an 
increase of loans and so of deposits would alter the per- 
centage of gold reserves and leave less for notes. And, 
as we have said, there is now, since the concentration of 
gold in the Reserve Banks, no large stock of outside gold 
on which to draw. The chart 2 published by the board 
for 1918 shows a very remarkable decline in the per- 
centage of cash reserves to deposit and note liabilities, 
due almost entirely to a rapid increase of Reserve notes. 
From the point of view, therefore, of banking principles 
and experience, there ought to be no such close dependence 
of both notes and deposits on one gold reserve. The 
experience of Germany ought to be conclusive; while 
the steady movement of our own system by the end of 
1919 in the same direction ought to force us to study 
the matter fully presented in the proposed bill of Chapter 

1 Cf. supra, pp. 16, 106, 135, 189, 256, 288, 305. 

2 Bulletin, January, 1919, p. 67. 



WORKING OF FEDERAL RESERVE ACT 317 

IX (Section 8). The amount and convertibility of our 
Reserve notes ought in no way to be determined by fiscal 
operations. 

Also, it should be remembered that there are yet non- 
member banks who can use Reserve notes in their reserves. 
Hence, their expansion of credit can go on as long as loans 
based on government securities can be rediscounted and 
notes be obtained thereby. The great task now immedi- 
ately before us is to reconstruct the provisions of the 
Federal Reserve Act in such a way as to place the 
quantity and the redeemability of the Federal Reserve 
notes above all influences arising from the fiscal opera- 
tions of the Treasury, or from the heaping up of un- 
liquid assets of any kind. 



APPENDIX I 

PLAN OF THE AMERICAN BANKERS' 
ASSOCIATION 

At a meeting of the Currency Commission of the American Bank- 
ers* Association, held in Chicago, January 18, 1908, there were laid 
before it the Aldrich Bill and the Fowler Bill. These bills were read 
section by section and discussed, and their provisions carefully con- 
sidered. After thorough discussion the Commission reported as fol- 
lows: 

ALDRICH BILL 

This bill proposes the issuing of additional bank notes based upon 
the security of other than United States bonds; namely, obligations 
of State, city or county, and first mortgage railway bonds. It is be- 
lieved that this scheme is impracticable, unwise and financially un- 
sound. 

I. It is a departure from a safe system of note issues, which has 
been enjoyed since the foundation of the National banking system; 
it is a step backwards to the conditions which gave rise to the issuing 
of "wild-cat" currency before the Civil War, which currency was 
based upon bonds of a similar description. It may be the entering 
wedge to the acceptance of undesirable bonds as security for note 
issues. There are recent examples in the laws of New York State 
legalizing such bonds for Savings Banks. 

n. The bill would not aid the business public in obtaining loans 
from banks in time of stress. In its practical operation it would 
cripple the lending power of the banks. Inasmuch as it is not good 
banking policy to hold any considerable amounts of such securities in 
the assets of commercial banks, the banks wishing to take out a new 
circulation would be obliged to purchase the new securities or to bor- 
row them. The direct means of obtaining securities not generally 
held in the assets of the banks, would be found only by taking from 
their cash reserves one hundred thousand dollars in lawful money, 
in order to issue notes of seventy-five thousand dollars. By this proc- 
ess the bank would decrease its lawful reserves, which form the basis 
of loans. If the bonds behind these notes were borrowed instead of 
purchased, it would have the effect of increasing the liabilities of the 

319 



320 APPENDIX I 

banks, which is wrong in principle and pernicious in practice. One 
hundred thousand dollars in lawful reserves would support loans of 
four hundred thousand dollars; while under the Aldrich Bill, one hun- 
dred thousand dollars taken from the reserves and invested in bonds, 
would only permit the lending of seventy-five thousand dollars. 
Thus, in its practical operation, it would seriously impair the ability 
of banks to meet the demands of the borrowing public. 

HE. This bill would tend to induce counties and municipalities to 
enlarge their obligations, because a fictitious bond market would be 
created. It would set a premium upon the increase of local indebted- 
ness, which would be highly detrimental. It should be no part of 
Government legislation to aid in marketing securities. 

IV. The necessity of ascertaining definite information as to popu- 
lation of cities, debt limits, valuation of taxable property, defaults, 
dividends on railway capital, and all other technical requirements, 
would entail such delays as to make the notes available only after the 
emergency had passed. A crisis is short, sharp and decisive; and the 
Aldrich Bill is a remedy offered to a man after recovery or death. 

V. The provision of the Aldrich Bill to tax such additional notes 
six per cent will make their cost prohibitive. Calculated on a basis 
of one hundred thousand dollars of bonds purchased at par, bearing 
four per cent per annum, and estimating the lending rate of money to 
be six per cent, the net loss to banks taking out such circulation, would 
be two thousand dollars per annum, or at the rate of two per cent. 

Illustration: 

cost of taking out notes against purchased bonds 

$100,000 loanable at six per cent $6,000 

Tax at six per cent on $75,000 4,500 

Total cost $10,500 

Four per cent int. on $100,000 of bonds $4,000 

Loan $75,000 at six per cent 4,500 

Total income 8,500 



Net loss $2,000 

This calculation does not include loss of interest on redemption 
fund nor the cost of printing and redemption of notes. When the 
price of such bonds becomes inflated by reason of their use as a basis 
of circulation, as in the case of United States bonds, the cost of the 
notes would be proportionately increased. If the bonds were bor- 
rowed instead of purchased, the cost of notes issued would be the 
same. 



APPENDIX I 321 

Illustration: 

cost of taking out notes against borrowed bonds 

Tax on $75,000 notes at six per cent $4,500 

Int. paid for use of $100,000 bonds at two per cent 2,000 

Total cost $6,500 

INCOME 

S.ix per cent interest on $75,000 4,500 

Net loss $2,000 

Calculation is exclusive of loss of interest on redemption fund, and 
the cost of printing and redemption of notes. 

It is thus proven that should banks be forced to take out these 
notes, the minimum rate to the borrower would be the actual cost of 
eight per cent, independent of any charge for the use of the capital, 
the expenses of doing business, and the risk of lending. If fair allow- 
ance be made for all legitimate charges, the net cost to borrowers 
would be as high as the prohibitive ten per cent tax now imposed by 
the Government on State bank issues. 

VI. The high cost of taking out these notes must obviously be 
paid by the needy borrower; and in that event the bill must be re- 
garded as a measure operating to tax the customer in a time when he 
especially requires assistance. Under normal conditions, a seasonal 
demand, arising in the autumn, causes higher rates of interest; while 
under the operation of the Aldrich Bill, the charge for currency needed 
in those periods, would be still further increased to the borrower. 
The enforced rise of interest rates would not only apply to loans 
effected by the use of such notes, but would at the same time increase 
the rates on the entire line of discounts carried by a bank, thus im- 
posing a heavy and unnecessary burden upon the agricultural and 
business interests of the whole community. For these reasons, the 
Commission finds itself obliged to express its disapproval of the 
Aldrich Bill. 

THE FOWLER BILL 

After deliberate consideration of all the provisions of House Bill 
12677, Sixtieth Congress, known as the New Fowler Bill, we disap- 
prove it. While it contains certain meritorious features, it introduces 
schemes so far-reaching in their scope and touching so many collateral 
interests not germane to the real solution of our currency difficulties, 
that we believe its passage would unsettle rather than improve finan- 
cial conditions. 

Let us not be unmindful of the fact that in response to the de- 
mands of the people unsound and radical legislation has had its prece- 



322 APPENDIX I 

dents in our monetary history. After the panic of 1873 the demand 
for some action with reference to currency was so strong that Con- 
gress passed a bill increasing greenbacks by forty-four million dollars, 
a project which was wisely vetoed by President Grant. After the 
panic of 1893, Congress gave its approval to a measure providing for 
the coinage of fifty-five million dollars of silver, which was vetoed by 
President Cleveland, who followed the excellent precedent established 
by President Grant. 

In these two instances we have had examples of hasty measures 
following financial panics, and in the two bills herein discussed we 
have what appears to us to be similar unwise measures following the 
recent crisis. 

THE BANKERS' PLAN 

The principles enunciated by the Commission, and approved by 
the American Bankers' Association in convention assembled at At- 
lantic City on September 23, 1907, have been at this time carefully 
reviewed, and we are still firm in the belief that they are economically 
sound. We have accordingly prepared a plan embodying these prin- 
ciples. 

The difference between the original plan of the Commission (em- 
bodied in House Bill 23017, Fifty-ninth Congress) and the present 
plan is to be found in the provision that the holder of a credit note, 
instead of being a general creditor, shall have a prior lien on the assets 
of the issuing bank. The notes thus issued would be automatically 
adjusted in volume to the demands for currency. The security to 
the notes thus provided by pledging the whole of the assets of a bank 
would afford more desirable protection to a note holder than a por- 
tion of those assets in a segregated form; and such notes can be issued 
under provisions which will insure absolute safety to the note holder; 
an ample supply of currency to the public; relief from the disturbed 
commercial conditions, such as those through which we have recently 
passed; and finally the certain retirement of the notes when they have 
fulfilled their purpose in the hands of the public. The plan proposed 
by the Commission is as follows: 

Section 1. Be it enacted by the Senate and House of Represen- 
tatives of the United States of America, in Congress Assembled, that 
from and after the passage of this Act, any national banking associa- 
tion which has been in business for one year, and has a surplus fund 
equal to twenty per centum of its capital may take out for issue and 
circulation national bank notes without a deposit of United States 
bonds as now provided by law. Said notes shall be known as "Na- 
tional Bank Guaranteed Credit Notes." Said notes shall be issued 
in such form and denominations, and under such rules and regula- 



APPENDIX I 323 

tions as the Comptroller of the Currency shall fix. The amount of 
said notes so taken out by any national banking association may be 
equal to forty per centum of the amount of its national bank notes 
at any time outstanding, which are secured by the deposit of govern- 
ment bonds, but shall not exceed in amount twenty-five per centum 
of its capital; provided, however, that if at any time in the future the 
present proportion of the total outstanding unmatured United States 
bonds to the total capitalization of all national banking associations 
in active operation shall dimmish, then the authorized issue of national 
bank guaranteed credit notes shall be increased to a correspondingly 
greater percentage of the bond-secured notes. 

Section 2. That every national banking association taking out 
national bank guaranteed credit notes in accordance with the fore- 
going section, shall pay to the Treasurer of the United States in the 
months of January and July a tax of one and one-quarter per centum 
upon the average amount of such notes in circulation during the pre- 
ceding half year. 

Section 3. That any national banking association which has 
taken out national bank guaranteed credit notes in accordance with 
the provisions of Section 1 of this Act, may take out a further amount 
of national bank guaranteed credit notes equal to twelve and one- 
half per centum of its capital, but it shall pay to the Treasurer of the 
United States in the months of January and July a tax of two and 
one-half per centum upon the average amount of such notes in cir- 
culation during the preceding half year. 

Section 4. That the total amount of bank notes issued by any 
national banking association, including national bank guaranteed 
credit notes taken out in accordance with the provisions of this Act, 
shall not exceed the amount of its paid-up capital. 

Section 5. That any national banking association situated and 
doing business in a Central Reserve City, or a Reserve City, shall at 
all times have on hand in lawful money of the United States, an amount 
equal to at least twenty-five per centum of its national bank guaranteed 
credit notes in circulation; and every other national banking associa- 
tion shall at all times have on hand in lawful money of the United 
States an amount equal to at least fifteen per centum of its guaranteed 
credit notes in circulation; provided, however, that any national 
banking association situated and doing business in a Reserve City 
may keep one-half of its lawful money reserve on deposit in a national 
bank in a Central Reserve City, or in a Reserve City, and that every 
national banking association situated and doing business outside of a 
Central Reserve City, or a Reserve City, may keep three-fifths of its 
lawful money reserve on deposit in a national bank in a Central Re- 
serve City, or in a Reserve City. 



3-24 APPENDIX I 

Section 6. That the taxes upon national bank guaranteed credit 
notes provided for in Sections -2 and 3 of this Act, shall be paid in 
lawful money to the Treasurer of the United States. Said taxes, when 
received, shall constitute a guaranty fund to redeem the notes of failed 
banks, and to pay the cost of printing and current redemption. 

Section 7. That when any national banking association takes out 
any national bank guaranteed credit notes for issue and circulation, 
it shall deposit with the Treasurer of the United States in lawful 
money an amount equal to five per centum thereof. The amount so 
deposits i shall be placed in the guaranty fund for the purposes thereof. 
But said amount shall be refunded to the respective banks as soon as 
the taxes provided for in Sections 2 and 3 of this Act maintain said 
guaranty fund above five per centum of the maximum amount of na- 
tional bank guaranteed credit notes taken out for issue and circula- 
tion, but that no bank shall withdraw any part of its deposit of said 
five per centum until it shall have to its credit in said fund more than 
five per centum. 

Section 8. That the Comptroller of the Currency shall designate 
certain cities conveniently located in the various sections of the United 
States for the current daily redemption of said national bank guar- 
anteed credit notes; he shall fix rules and regulations for such re- 
demption: and, before authorizing and permitting any national bank- 
: x-iation to take out for issue and circulation any national bank 
guaranteed credit notes, he shall require such bank to make arrange- 
ments satisfactory to h im for the current daily redemption of such 
notes in every redemption city so designated. 

Section 9. That said national bank guaranteed credit notes, 
issued in accordance with the provisions of this Act shall be received 
at par in all parts of the United States in payment of taxes, excises, 
public lands, and all other dues to the United States, except duties on 
imports: and also for all salaries and other debts and demands owing 
by the United States to individuals, corporations, and associations 
within the United States except interest on public debt and in redemp- 
tion of the national currency. Said notes shall be received upon de- 
posit and for all purposes of debt and liability by every national bank- 
ing association at par and without charge of whatsoever kind. 

Section 10. That the holder of any national bank guaranteed 
credit note shall have a prior lien on the assets of the national banking 
association issuing it and on the statutory liability of shareholders. 

Section 11. That upon the failure of a national banking associa- 
tion, all outstanding national bank guaranteed credit notes taken out 
by it in accordance with the provisions of this Act. shall upon presen- 
tation to the United States Treasurer be paid in lawful money out of 
the guaranty fund; but the United States Treasurer shall recover in 



APPENDIX I 325 

lawful money from the assets of the failed bank the amount of the 
guaranteed credit notes of such bank outstanding at the time of failure, 
and the same shall be paid into the guaranty fund as provided in Sec- 
tion 10 of this Act. 

Section 12. That any national banking association desiring to 
retire its national bank guaranteed credit notes or to go into liquida- 
tion shall pay into the guaranty fund an amount of lawful money 
equal to the amount of its national bank guaranteed credit notes then 
outstanding. 

Section 13. That any national banking association desiring to 
take out national bank guaranteed credit notes and having notes out- 
standing in excess of sixty-two and one-half per centum of its paid-up 
capital, to secure the payment of which United States bonds have 
been deposited, may, upon the deposit of lawful money, redeem such 
excess without reference to the limitation of nine million dollars each 
month prescribed in the Act approved March fourth, nineteen hundred 
and seven. 



APPENDIX II 

PLAN OF THE NATIONAL MONETARY 
COMMISSION * 

A BILL 

To Incorporate the National Reserve Association of the 
United States, and for Other Purposes 

Be it enacted by the Senate and House of Representatives of the United 
States of America in Congress assembled, That the National Reserve 
Association of the United States be, and it is hereby, created and 
established for a term of fifty years from the date of filing with the 
Comptroller of the Currency a certificate of paid-in capital stock as 
hereinafter provided. It shall have an authorized capital equal in 
amount to twenty per centum of the paid-in and unimpaired capital 
of all banks eligible for membership in said National Reserve Asso- 
ciation. Before said association shall be authorized to commence 
business two hundred million dollars of the capital stock shall be sub- 
scribed and one hundred million dollars of its capital shall be paid in 
cash. The capital stock of said association shall be divided into shares 
of one hundred dollars each. The outstanding capital stock may be 
increased from time to time as subscribing banks increase their capital 
or as additional banks become subscribers or may be decreased as 
subscribing banks reduce their capital or leave the association by 
liquidation. The head office of the National Reserve Association 
shall be located in Washington, in the District of Columbia. 

Sec. 2. Upon duly making and filing with the Comptroller of the 
Currency the certificate hereinafter required the National Reserve 
Association of the United States shall become a body corporate and 
as such and by that name shall have power — 

First. To adopt and use a corporate seal. 

Second. To have succession for a period of fifty years from the 
date of said certificate. 

Third. To make all contracts necessary and proper to carry out 
the purposes of this act. 

1 The first tentative plan was proposed by the chairman, Senator Aldrich, 
January 16, 1911; a revised outline, October 14, 1911; and the final plan with 
a report was laid before Congress January 8, 1912. 



APPENDIX II 327 

Fourth. To sue and be sued, complain and defend, in any court of 
law or equity, as fully as natural persons. 

Fifth. To elect or appoint directors and officers in the manner 
hereinafter provided and define their duties. 

Sixth. To adopt by its board of directors by-laws not inconsistent 
with this act, regulating the manner in which its property shall be 
transferred, its general business conducted, and the privileges granted 
to it by law exercised and enjoyed. 

Seventh. To purchase, acquire, hold, and convey real estate as 
hereinafter provided. 

Eighth. To exercise by its board of directors or duly authorized 
committees, officers, or agent, subject to law, all the powers and priv- 
ileges conferred upon the National Reserve Association by the act. 

Sec. 8. All national banks, and all banks or trust companies char- 
tered by the laws of any State of the United States or of the District 
of Columbia, complying with the requirements for membership in 
the said National Reserve Association, hereinafter set forth, may sub- 
scribe to its capital to an amount equal to twenty per centum of the 
paid-in and unimpaired capital of the subscribing bank, and not more 
nor less; and each of such subscribing banks shall become a member 
of a local association as hereinafter provided. Fifty per centum of the 
subscriptions to the capital stock of the National Reserve Association 
shall be fully paid in; the remainder of the subscriptions or any part 
thereof shall become a liability of the subscribers, subject to call and 
payment thereof whenever necessary to meet the obligations of the 
National Reserve Association under such terms and in accordance 
with such regulations as the board of directors of the National Reserve 
Association may prescribe. 

The subscriptions of a bank or trust company incorporated under 
the laws of any State or of the District of Columbia to the capital 
stock of the National Reserve Association shall be made subject to the 
following conditions: 

First. That (a) if a bank, it shall have a paid-in and unimpaired 
capital of not less than that required for a national bank in the same 
locality; and that (b) if a trust company, it shall have an unimpaired 
surplus of not less than twenty per centum of its capital, and if located 
in a place having a population of six thousand inhabitants or less shall 
have a paid-in and unimpaired capital of not less than fifty thousand 
dollars; if located in a city having a population of more than six 
thousand inhabitants and not more than fifty thousand inhabitants, 
shall have a paid-in and unimpaired capital of not less than one hun- 
dred thousand dollars; if located in a city having a population of more 
than fifty thousand inhabitants and not more than two hundred thou- 
sand inhabitants shall have a paid-in and unimpaired capital of not 



328 APPENDIX H 

less than two hundred thousand dollars; if located in a city having a 
population of more than two hundred thousand inhabitants and not 
more than three hundred thousand inhabitants shall have a paid-in 
and unimpaired capital of not less than three hundred thousand dol- 
lars; if located in a city having a population of more than three hun- 
dred thousand inhabitants and not more than four hundred thousand 
inhabitants shall have a paid-in and unimpaired capital of not less 
than four hundred thousand dollars, and if located in a city having a 
population of more than four hundred thousand inhabitants shall have 
a paid-in and unimpaired capital of not less than five hundred thou- 
sand dollars. 

Second. That it shall have and agree to maintain against its de- 
mand deposits a reserve of like character and proportion to that re- 
quired by law of a national bank in the same locality: Provided, how- 
ever, That deposits which it may have with any subscribing national 
bank, State bank, or trust company in a city designated in the national 
banking laws as a reserve city or a central reserve city shall count as 
reserve in like manner and to the same extent as similar deposits of a 
national ba nk with national banks in such cities. 

Third. That it shall have and agree to maintain against other 
classes of deposits the percentages of reserve required by this act. 

Fourth. That it shall agree to submit to such examinations and to 
make such reports as are required by law and to comply with the re- 
quirements and conditions imposed by this act and regulations made 
in conformity therewith. 

The words '"'subscribing banks" when used hereafter in this act 
shall be understood to refer to such national banks, and banks or 
trust companies chartered by the laws of any State of the United 
States or of the District of Columbia, as shall comply with the re- 
quirements for membership herein defined. 

Sec. 4. The Secretary of the Treasury, the Secretary of Agricul- 
ture, the Secretary of Commerce and Labor, and the Comptroller of 
the Currency are hereby designated a committee to effect the organi- 
zation of the National Reserve Association, and the necessary expenses 
of said committee shall be payable out of the Treasury upon vouchers 
approved by the members of said committee, and the Treasury shall 
be reimbursed by the National Reserve Association to the full amount 
paid out therefor. 

"Within sixty days after the passage of this act said committee shall 
provide for the opening of books for subscriptions to the capital stock 
of said National Reserve Association in such places as the said com- 
mittee may designate. Before the subscription of any bank to the 
capital stock of the National Reserve Association shall be accepted, 
said bank shall file with the organization committee or after organiza- 



APPENDIX II 329 

tion with the National Reserve Association a certified copy of a reso- 
lution adopted by the board of directors of said bank accepting all the 
provisions and liabilities imposed by this act and authorizing the presi- 
dent or cashier of said bank to subscribe for said stock. 

Sec. 5. When the subscriptions to the capital stock of the Na- 
tional Reserve Association shall amount to the sum of two hundred 
million dollars the organization committee hereinbefore provided shall 
forthwith proceed to select fifteen cities in the United States for the 
location of the branches of said National Reserve Association: Pro- 
vided, That one branch shall be located in the New England States, 
including the States of Maine, New Hampshire, Vermont, Massa- 
chusetts, Rhode Island, and Connecticut; two branches in the East- 
ern States, including the States of New York, New Jersey, Pennsyl- 
vania, and Delaware; four branches in the Southern States, including 
the States of Maryland, Virginia, West Virginia, North Carolina, South 
Carolina, Georgia, Florida, Alabama, Mississippi, Louisiana, Texas, 
Arkansas, Kentucky, Tennessee, and also the District of Columbia; 
four branches in the Middle Western States, including the States of 
Ohio, Indiana, Illinois, Michigan, Wisconsin, Minnesota, Iowa, and 
Missouri; four branches in the Western and Pacific States, including 
the States of North Dakota, South Dakota, Nebraska, Kansas, Mon- 
tana, Wyoming, Colorado, New Mexico, Oklahoma, Washington, 
Oregon, California, Idaho, Utah, Nevada, and Arizona. 

When the cities in which the branches are to be located have been 
selected the organization committee shall forthwith divide the entire 
country into fifteen districts, with one branch of the National Reserve 
Association in each district: Provided, That the districts shall be ap- 
portioned with due regard to the convenient and customary course of 
business and not necessarily along State lines. 

The districts may be readjusted, and new districts and new branches 
may from time to time be created by the directors of the National 
Reserve Association whenever, in their opinion, the business of the 
country requires. 

Sec. 6. All subscribing banks within a district shall be grouped 
by the organization committee or after organization, by the National 
Reserve Association, into local associations of not less than ten banks, 
with an aggregate capital and surplus of at least five million dollars, 
for the purposes hereinafter prescribed: Provided, That the territory 
included in each association shall be contiguous and that in appor- 
tioning the territory due regard shall be had for the customary course 
of business and for the convenience of the banks forming the associa- 
tion: Provided further, That in apportioning the territory to local asso- 
ciations comprising a district every bank and all of the territory within 
said district shall be located within the boundaries of some local asso- 



330 APPENDIX II 

ciation : And provided further, That every subscribing bank shall be- 
come a member only of the local association of the territory in which 
it is situated. 

The banks uniting to form a local association shall, by their presi- 
dents or vice presidents, under authority from the board of directors, 
execute a certificate in triplicate setting forth the name of the associa- 
tion, the names of the banks composing it, its principal place of busi- 
ness, its territorial limits, and the purposes for which it is organized. 
One copy of this certificate shall be filed with the Comptroller of the 
Currency, one copy shall be filed with the National Reserve Associa- 
tion, and one copy shall be filed with the branch of the National Re- 
serve Association of the district in which the local association is in- 
cluded. Upon the filing of such certificates the local association 
therein named shall become a body corporate and by the name so 
designated may sue and be sued and exercise the powers of a body 
corporate for the purposes mentioned in this act, and not otherwise. 

The local associations in each district may be readjusted from time 
to time and new associations may be authorized by the directors of 
the National Reserve Association. 

Sec. 7. Each local association shall have a board of directors, the 
number to be determined by the by-laws of the local association. 
Three-fifths of that number shall be elected by ballot cast by the rep- 
resentatives of the banks that are members of the local association, 
each bank having one representative and each representative one vote 
for each of the positions to be filled without reference to the number 
of shares which the bank holds in the National Reserve Association. 
Two-fifths of the whole number of directors of the local association 
shall be elected by the same representatives of the several banks that 
are members of the association, but in voting for these additional di- 
rectors each representative shall be entitled to as many votes as the 
bank which he represents holds shares in the National Reserve Asso- 
ciation: Provided, That in case forty per centum of the capital stock 
in any subscribing bank is owned directly or indirectly by any other 
subscribing bank, or in case forty per centum of the capital stock in 
each of two or more subscribing banks, being members of the same 
local association, is owned directly or indirectly by the same person, 
persons, copartnership, voluntary association, trustee, or corporation, 
then and in either of such cases, neither of such banks shall be entitled 
to vote separately, as a unit, or upon its stock, except that such banks 
acting together, as one unit, shall be entitled to one vote, for the elec- 
tion of the board of directors of such local association. In no case 
shall voting by proxy be allowed. The authorized representative of a 
bank, as herein provided, shall be its president, vice president, or 
cashier. 



APPENDIX II 331 

Each director shall take an oath that he will, so far as the duty 
devolves upon him, diligently and honestly administer the affairs of 
such association and will not knowingly violate or willingly permit to 
be violated any of the provisions of this act. 

The directors originally elected shall hold office until the second 
Tuesday in February immediately following their election, and there- 
after the directors shall be elected annually on that date and shall 
hold office for the term of one year. 

The board of directors of the local association shall have authority 
to make by-laws, not inconsistent with law, which shall be subject to 
the approval of the National Reserve Association. 

Sec. 8. Each of the branches of the National Reserve Association 
shall have a board of directors, the number, not less than twelve in 
addition to the ex officio member, to be fixed by the by-laws of the 
branch. These directors shall be elected in the following manner: 

The board of directors of each local association shall elect by ballot 
a voting representative. One-half of the elected directors of the 
branch shall be elected by the vote of such representatives, each rep- 
resentative having one vote for each of the positions to be filled, 
without reference to the number of shares which the banks composing 
the association which he represents holds in the National Reserve 
Association. One-third of the elected directors shall be elected by 
the same voting representatives, but each voting representative in 
this case shall have a number of votes equal to the number of shares 
in the National Reserve Association held by all the banks composing 
the local association which he represents. The remaining one-sixth 
of the directors shall be chosen by the directors already elected and 
shall fairly represent the agricultural, commercial, industrial, and other 
interests of the district and shall not be officers nor, while serving, 
directors of banks, trust companies, insurance companies, or other 
financial institutions. The manager of the branch shall be ex officio 
a member of the board of directors of the branch and shall be chair- 
man of the board. 

Each director shall take an oath that he will, so far as the duty de- 
volves upon him, diligently and honestly administer the affairs of 
such association and will not knowingly violate or willingly permit to 
be violated any of the provisions of this act. 

All the members of the board of directors of the branch except the 
ex officio member shall at the first meeting of the board be divided 
into three classes. One-third of the directors shall hold office until 
the first Tuesday in March immediately following the election; one- 
third of the directors shall hold office for an additional period of one 
year after the first Tuesday in March immediately following the elec- 
tion; the remaining one-third of the directors shall hold office for an 



332 APPENDIX II 

additional period of two years after the first Tuesday in March im- 
mediately following the election. All elections shall be held on the 
first Tuesday in March of each year, and after the first election all 
directors shall be elected for a term of three years : Provided, That the 
by-laws of the National Reserve Association shall provide for the man- 
ner of filling any vacancies which may occur in the board of directors 
of the branches. 

The board of directors of the branch shall have authority to make 
by-laws, not inconsistent with law, which shall be subject to the ap- 
proval of the National Reserve Association. 

Sec. 9. The National Reserve Association shall have a board of 
directors, to be chosen in the following manner: 

First. Fifteen directors shall be elected, one by the board of di- 
rectors of each branch of the National Reserve Association. In case 
the number of districts shall be increased hereafter, each additional 
district shall be entitled to elect an additional director of this class. 

Second. Fifteen additional directors shall be elected, one by the 
board of directors of each branch of the National Reserve Association, 
who shall fairly represent the agricultural, commercial, industrial, and 
other interests of the district, and who shall not be officers nor, while 
serving, directors of banks, trust companies, insurance companies, or 
other financial institutions. In case the number of districts shall be 
increased hereafter, each additional district shall be entitled to elect 
an additional director of this class. 

Third. Nine additional directors shall be elected by voting rep- 
resentatives chosen by the boards of directors of the various branches, 
each of whom shall cast a number of votes equal to the number of 
shares in the National Reserve Association held by the banks in the 
branch which he represents. Not more than one of the directors of 
this class shall be chosen from one district. Directors of each of the 
three classes named above shall be residents of the district from which 
they are elected. 

Fourth. There shall be seven ex officio members of the board of 
directors, namely: The governor of the National Reserve Associa- 
tion, who shall be chairman of the board, two deputy governors of 
the National Reserve Association, the Secretary of the Treasury, the 
Secretary of Agriculture, the Secretary of Commerce and Labor, and 
the Comptroller of the Currency. 

No member of any national or State legislative body shall be a di- 
rector of the National Reserve Association, nor of any of its branches, 
nor of any local association. 

All the members of the board, except the ex officio members, shall 
at the first meeting of the board be divided into three classes. One- 
third of the directors shall hold office until the first Tuesday in April 



APPENDIX II 333 

immediately following the election; one- third of the directors shall 
hold office for an additional period of one year after the first Tuesday 
in April immediately following the election; the remaining one-third 
of the directors shall hold office for an additional period of two years 
after the first Tuesday in April immediately following the election. 
All elections shall be held on the first Tuesday in April of each year, 
and after the first election all directors shall be elected for a term of 
three years: Provided, That all directors provided for in sections seven, 
eight, and nine of this Act shall serve until their successors have quali- 
fied: And provided further, That the by-laws of the National Reserve 
Association shall provide for the manner of filling any vacancies which 
may occur in the board of directors of the National Reserve Associa- 
tion. 

Each director shall take an oath that he will, so far as the duty 
devolves upon him, diligently and honestly administer the affairs of 
such association and will not knowingly violate or willingly permit to 
be violated any of the provisions of this act, 

The board of directors of the National Reserve Association shall 
have authority to make by-laws, not inconsistent with law, which 
shall prescribe the manner in which the business of said association 
shall be conducted and the privileges granted to it by law exercised 
and enjoyed. 

Sec. 10. The executive officers of the National Reserve Associa- 
tion shall consist of a governor, two deputy governors, a secretary, 
and such subordinate officers as may be provided by the by-laws. 
The governor of the National Reserve Association shall be selected by 
the President of the United States from a list of not less than three 
submitted to him by the board of directors of said association. The 
person so selected shall thereupon be appointed by the said board as 
governor of the National Reserve Association for a term of ten years, 
subject to removal for cause by a two-thirds vote of the board. There 
shall be two deputy governors, to be elected by the board, for a term 
of seven years, subject to removal for cause by a majority vote of the 
board. The two deputy governors first elected shall serve for terms 
of four years and seven years, respectively. In case of any vacancy 
in the office of deputy governor his successor shall be elected to fill 
the unexpired term. In the absence of the governor or his inability 
to act the deputy who is senior in point of service shall act as governor. 
The board of directors shall have authority to appoint such other 
officers as may be provided for by the by-laws. 

Sec. 11. When the National Reserve Association is duly organized 
its board of directors shall call upon the subscribing banks for a pay- 
ment of fifty per centum on the amount of their subscriptions to the 
capital stock of said association. When one hundred million dollars 



334 APPENDIX U 

of capital have been paid in the board of directors shall at once pro- 
ceed to execute and file with the Secretary of State a certificate show- 
ing the payment of one hundred million dollars on capital stock, and 
they shall further file with the Comptroller of the Currency a certificate 
showing the title and location of each bank which has subscribed to 
the capital stock of the National Reserve Association, the number of 
shares subscribed by each, and the amount paid thereon. 

Sec. 12. Shares of the capital stock of the National Reserve Asso- 
ciation shall not be transferable, and under no circumstances shall 
they be hypothecated nor shall they be owned otherwise than by 
subscribing banks, nor shall they be owned by any such bank other 
than in the proportion herein provided. In case a subscribing bank 
increases its capital it shall thereupon subscribe for an additional 
amount of the capital of the National Reserve Association equal to 
twenty per centum of the bank's increase of capital, paying therefor 
its then book value as shown by the last published statement of said 
association. A bank applying for membership in the National Re- 
serve Association at any time after its formation must subscribe for 
an amount of the capital of said association equal to twenty per cen- 
tum of the capital of said subscribing bank, paying therefor its then 
book value as shown by the last published statement of said associa- 
tion. When the capital of the National Reserve Association has been 
increased either on account of the increase of capital of the banks in 
said association or on account of the increase in the membership of 
said association, the board of directors shall make and execute a cer- 
tificate showing said increase in capital, the amount paid in and by 
whom paid. This certificate shall be filed in the office of the Comp- 
troller of the Currency. In case a subscribing bank reduces its cap- 
ital it shall surrender a proportionate amount of its holdings in the 
capital of said association, and if a bank goes into voluntary liquida- 
tion it shall surrender all of its holdings of the capital of said associa- 
tion. In either case the shares surrendered shall be canceled and the 
bank shall receive in payment therefor a sum equal to their then book 
value as shown by the last published statement of said association. 

If any member of the National Reserve Association shall become 
insolvent and a receiver be appointed, the stock held by it in said asso- 
ciation shall be canceled 'and the balance, after paying all debts due 
by such insolvent bank to said association (such debts being hereby 
declared to be a first lien upon the paid-in capital stock), shall be 
paid to the receiver of the insolvent bank. 

Whenever the capital stock of the National Reserve Association is 
reduced, either on account of the reduction in capital of members of 
said association or the liquidation or insolvency of any member, the 
board of directors shall make and execute a certificate showing such 



APPENDIX II 335 

reduction of capital stock and the amount repaid to each bank. This 
certificate shall be filed in the office of the Comptroller of the Cur- 
rency. 

Sec, 13. The National Reserve Association and its branches and 
the local associations shall be exempt from local and State taxation 
except in respect to taxes upon real estate. 

Sec. 14. The directors of the National Reserve Association shall 
annually elect from their number an executive committee and such 
other committees as the by-laws of the National Reserve Association 
may provide. The executive committee shall consist of nine members, 
of which the governor of the National Reserve Association shall be 
ex officio chairman and the two deputy governors and the Comptroller 
of the Currency ex officio members, but not more than one of the 
elected members shall be chosen from any one district. 

The executive committee shall have all the authority which is vested 
in the board of directors, except the power of nomination, appoint- 
ment, and removal of the governor and deputy governors and except 
such as may be specifically delegated by the board to other com- 
mittees or to the executive officers, or such as may be specifically re- 
served or retained by the board. 

Sec. 15. There shall be a board of examination elected annually 
by the board of directors from among their number, excluding the 
members of the executive committee, of which the Secretary of the 
Treasury shall be ex officio chairman. It shall be the duty of this 
board to carefully examine the condition and the business of the 
National Reserve Association and of its branches and to make a public 
statement of the result of such examination at least once a year. 

Sec. 16. Each branch shall have a manager and a deputy manager 
appointed from the district by the governor of the National Reserve 
Association with the approval of the executive committee of said asso- 
ciation and the board of directors of the branch, and subject to re- 
moval at any time by the governor with the approval of the executive 
committee of the National Reserve Association. The powers and 
duties of the manager and deputy manager and of the various com- 
mittees of the branches shall be prescribed by the by-laws of the Na- 
tional Reserve Association. 

Sec. 17. The directors of each local association shall annually 
elect from their number a president, a vice president, and an execu- 
tive committee, whose powers and duties shall be determined by the 
by-laws of the local association, subject, however, to the approval of 
the National Reserve Association. 

Sec. 18. The National Reserve Association shall cause to be kept 
at all times, at the head office of the association, a full and correct list 
of the names of the banks owning stock in the association and the num- 



336 APPENDIX II 

ber of shares held by each. Such list shall be subject to the inspection 
of all the shareholders of the association, and a copy thereof on the 
first Monday of July of each year shall be transmitted to the Comp- 
troller of the Currency. 

Sz:. 19. The earnings of the National Reserve Association shall 
be disposed of in the following manner: 

After the payment of all expenses and the franchise and other taxes 
not provided for in this section the shareholders shall be entitled to 
receive an annual dividend of four per centum on the paid-in capital, 
which dividend shall be cumulative. Further annual net earnings 
shall be disposed of as follows: First, a contingent fund shall be cre- 
ated, which shall be maintained at an amount equal to one per cen- 
tum on the paid-in capital, and shall not exceed in any event two 
milli on dollars and shall be used to meet any possible losses. Such 
fund shall, upon the final dissolution of the National Reserve Associa- 
tion, be paid to the United States and shall not under any circum- 
stances be included in the book value of the stock or be paid to the 
shareholders. Second, one-half of additional net earnings shall be 
paid into the surplus fund of the National Reserve Association until 
said fund shall amount to twenty per centum of the paid-in capital, 
one-fourth shall be paid to the United States as a franchise tax, and 
one-fourth shall be paid to the shareholders, until the shareholders' 
dividend shall amount to five per centum per annum on the paid-in 
capital: Provided, That no such dividends, exclusive of the cumulative 
dividends above provided for, shall at any time be paid in excess of 
five per centum in any one year. Whenever and so long as the con- 
tingent fund has been provided for and the five per centum dividend 
has been paid to shareholders one-half of the additional earnings shall 
be added to the surplus fund, and one-half shall be paid to the United 
States as a franchise tax. Whenever and so long as the surplus fund 
of the National Reserve Association amounts to twenty per centum 
of the paid-in capital and the shareholders shall have received divi- 
dends not exceeding five per centum, all excess earnings shfll be paid 
to the United States as a franchise tax. 

Sec. 20. Any member of a local association may ?; . : y to such 
association for a guaranty of the commercial paper flinch it desires 
to rediscount at the branch of the National Reserve Association in its 
district. Any such bank receiving a guaranty from a local association 
shall pay a commission to the local association, to be fixed in each case 
by its board of directors. Expenses and losses in excess of commis- 
sions shall be met by an assessment of the members of the local asso- 
ciation in proportion to the ratio which then capital and surplus bears 
to the aggregate capital and surplus of the members of the local 
ciation, which assessment shall be made by its board of directors, and 



APPENDIX II 337 

the commission received for such guaranty, after the payment of ex- 
penses and possible losses, shall be distributed among the several banks 
of the local association in the same proportion. A local association 
shall have authority to require security from any bank offering paper 
for guaranty, or it may decline to grant the application. The total 
amount of guaranties by a local association to the National Reserve 
Association shall not at any time exceed the aggregate capital and 
surplus of the banks forming the guaranteeing association. 

Sec. 21. Any local association may by a vote of three-fourths of 
its members and with the approval of the National Reserve Associa- 
tion, assume and exercise such of the powers and functions of a clear- 
ing house as are not inconsistent with the purposes of this act. The 
National Reserve Association may require any local association to 
perform such services in facilitating the domestic exchanges of the 
National Reserve Association as the public interests may require. 

Sec. 22. All of the privileges and advantages of the National Re- 
serve Association shall be equitably extended to every bank of any of 
the classes herein defined which shall subscribe to its proportion of 
the capital stock of the National Reserve Association and shall other- 
wise conform to the requirements of this act: Provided, That the Na- 
tional Reserve Association may suspend a bank from the privileges of 
membership for refusal to comply with such requirements or for a 
failure for thirty days to maintain its reserves, or to make the reports 
required by this act, or for misrepresentation in any report or exam- 
ination as to its condition or as to the character or extent of its assets 
or liabilities. 

Sec. 23. The National Reserve Association shall be the principal 
fiscal agent of the United States. The Government of the United 
States shall upon the organization of the National Reserve Associa- 
tion deposit its general funds with said association and its branches, 
and thereafter all receipts of the Government, exclusive of trust funds, 
shall be deposited with said Association and its branches, and all dis- 
bursements by the Government shall be made through said associa- 
tion and its branches. 

Sec. 24. The Government of the United States and banks own- 
ing stock in the National Reserve Association shall be the only deposi- 
tors in said association. All domestic transactions of the National 
Reserve Association shall be confined to the Government and the 
subscribing banks, with the exception of the purchase or sale of Gov- 
ernment or State securities or securities of foreign governments or of 
gold coin or bullion. 

Sec. 25. The National Reserve Association shall pay no interest 
on deposits. 

Sec. 26. The National Reserve Association may through a branch 



338 APPENDIX II 

rediscount for and with the indorsement of any bank having a deposit 
with it, notes and bills of exchange arising out of commercial transac- 
tions; that is, notes and bills of exchange issued or drawn for agricul- 
tural, industrial, or commercial purposes, and not including notes or 
bills issued or drawn for the purpose of carrying stocks, bonds, or other 
investment securities. 

Such notes and bills must have a maturity of not more than twenty- 
eight days, and must have been made at least thirty days prior to 
the date of rediscount. The amount so rediscounted shall at no time 
exceed the capital of the bank for which the rediscounts are made. 
The aggregate of such notes and bills bearing the signature or indorse- 
ment of any one person, company, firm, or corporation, rediscounted 
for any one bank, shall at no time exceed ten per centum of the un- 
impaired capital and surplus of said bank. 

Sec. 27. The National Reserve Association may through a branch 
also rediscount, for and with the indorsement of any bank having a 
deposit with it, notes and bills of exchange arising out of commercial 
transactions as hereinbefore defined, having more than twenty-eight 
days, but not exceeding four months, to run, but in such cases the 
paper must be guaranteed by the local association of which the bank 
asking for the rediscount is a member. 

Sec. 28. Whenever, in the opinion of the governor of the National 
Reserve Association, the public interests so require, such opinion to 
be concurred in by the executive committee of the National Reserve 
Association and to have the definite approval of the Secretary of the 
Treasury, the National Reserve Association may through a branch 
discount the direct obligation of a depositing bank, indorsed by its 
local association, provided that the indorsement of the local associa- 
tion shall be fully secured by the pledge and deposit with it of satis- 
factory securities, which shall be held by the local association for ac- 
count of the National Reserve Association; but in no such case shall 
the amount loaned by the National Reserve Association exceed three- 
fourths of the actual value of the securities so pledged. 

Sec. 29. The power of rediscount and discount granted to the 
National Reserve Association by sections twenty-six, twenty-seven, 
and twenty-eight of this act shall in each case be exercised through 
the branch in the district in which the bank making the application 
is located. 

Sec. 30. The National Reserve Association shall have authority 
to fix its rates of discount from time to time, which when so fixed 
shall be published, and shall be uniform throughout the United States. 

Sec. 31. National banks are hereby authorized to accept drafts 
or bills of exchange drawn upon them, having not more than four 
months to run, properly secured, and arising out of commercial trans- 



APPENDIX II 339 

actions as hereinbefore defined. The amount of such acceptances 
outstanding shall not exceed one-half the capital and surplus of the 
accepting bank, and shall be subject to the restrictions of section fifty- 
two hundred of the Revised Statutes. 

Sec. 32. The National Reserve Association may, whenever its 
own condition and the general financial conditions warrant such in- 
vestment, purchase from a subscribing bank acceptances of banks or 
acceptors of unquestioned financial responsibility arising out of com- 
mercial transactions as hereinbefore defined. Such acceptances must 
have not exceeding ninety days to run, and must be of a character 
generally known in the market as prime bills. Such acceptances shall 
bear the indorsement of the subscribing bank selling the same, which 
indorsement must be other than that of the acceptor. 

Sec. 33. The National Reserve Association may invest in United 
States bonds; also in obligations, having not more than one year to 
run, of the United States or its dependencies, or of any State, or of 
foreign governments. 

Sec. 34. The National Reserve Association shall have power, both 
at home and abroad, to deal in gold coin or bullion, to make loans 
thereon, and to contract for loans of gold coin or bullion, giving there- 
for, when necessary, acceptable security, including the hypothecation 
of any of its holdings of United States bonds. 

Sec. 35. The National Reserve Association shall have power to 
purchase from its subscribing banks and to sell, with or without its 
indorsement, checks or bills of exchange, arising out of commercial 
transactions as hereinbefore defined, payable in such foreign coun- 
tries as the board of directors of the National Reserve Association 
may determine. These bills of exchange must have not exceeding 
ninety days to run, and must bear the signatures of two or more re- 
sponsible parties, of which the last one shall be that of a subscribing 
bank. 

Sec. 36. The National Reserve Association shall have power to 
open and maintain banking accounts in foreign countries and to estab- 
lish agencies in foreign countries for the purpose of purchasing, selling, 
and collecting foreign bills of exchange, and it shall have authority to 
buy and sell, with or without its indorsement, through such corre- 
spondents or agencies, checks or prime foreign bills of exchange arising 
out of commercial transactions, which have not exceeding ninety 
days to run, and which bear the signatures of two or more responsible 
parties. 

Sec. 37. It shall be the duty of the National Reserve Association 
or any of its branches, upon request, to transfer any part of the de- 
posit balance of any bank having an account with it to the credit of 
any other bank having an account with the National Reserve Asso- 



340 APPENDIX II 

ciation. If a deposit balance is transferred from the books of one 
branch to the books of another branch, it may be done, under regula- 
tions to be prescribed by the National Reserve Association, by mail, 
telegraph, or otherwise, at rates to be fixed at the time by the man- 
ager of the branch at which the transaction originates. 

Sec. 38. The National Reserve Association may purchase, ac- 
quire, hold, and convey real estate for the following purposes and for 
no other: 

First. Such as shall be necessary for the immediate accommoda- 
tion in the transaction of the business either of the head office or of 
the branches. 

Second. Such as shall be mortgaged to it in good faith by way of 
security for debts previously contracted. 

Third. Such as shall be conveyed to it in satisfaction of debts 
previously contracted in the course of its dealings. 

Fourth. Such as it shall purchase at sales under judgments, de- 
crees, or mortgages held by said association, or shall purchase to secure 
debts due to it. 

But the National Reserve Association shall not hold the possession 
of any real estate under mortgage or the title and possession of any 
real estate purchased to secure any debts due to it for a longer period 
than five years. 

Sec. 39. All subscribing banks must conform to the following re- 
quirements as to reserves to be held against deposits of various classes, 
but the deposit balance of any subscribing bank in the National Re- 
serve Association and any notes of the National Reserve Association 
which it holds may be counted as the whole or any part of its required 
reserve : 

First. On demand deposits: National banks in different localities 
shall maintain the same percentages of reserve against demand de- 
posits as is now required by law, and the same percentages of reserve 
against demand deposits shall be required of all other subscribing 
banks in the same localities. 

Second. On time deposits: All time deposits and moneys held in 
trust payable or maturing within thirty days shall be subject to the 
same reserve requirements as demand deposits in the same locality. 
All time deposits and moneys held in trust payable or maturing more 
than thirty days from date shall be subject to the same reserve require- 
ments as demand deposits for the thirty days preceding their maturity, 
but no reserves shall be required therefor except for this period. Such 
time deposits and moneys held in trust, payable only at a stated time 
not less than thirty days from date of deposit, must be represented by 
certificates or instruments in writing and must not be allowed to be 
withdrawn before the time specified without thirty days' notice. 



APPENDIX II 341 

Sec. 40. National banks may loan not more than thirty per cen- 
tum of their time deposits, as herein defined, upon improved and un- 
encumbered real estate, such loans not to exceed fifty per centum of 
the actual value of the property, which property shall be situated in 
the vicinity or in the territory directly tributary to the bank: Pro- 
vided, That this privilege shall not be extended to banks acting as re- 
serve agents for banks or trust companies. 

Sec. 41. All demand liabilities, including deposits and circulating 
notes, of the National Reserve Association shall be covered to the 
extent of fifty per centum by a reserve of gold (including foreign gold 
coin and gold bullion) or other money of the United States which the 
national banks are now authorized to hold as a part of their legal re- 
serve: Provided, That whenever and so long as such reserve shall fall 
and remain below fifty per centum the National Reserve Association 
shall pay a special tax upon the deficiency of reserve at a rate increas- 
ing in proportion to such deficiency as follows : For each two and one- 
half per centum or fraction thereof that the reserve falls below fifty 
per centum a tax shall be levied at the rate of one and one-half per 
centum per annum: Provided further, That no additional circulating 
notes shall be issued whenever and so long as the amount of such re- 
serve falls below thirty-three and one-third per centum of its out- 
standing notes. 

Sec. 42. In computing the demand liabilities of the National Re- 
serve Association a sum equal to one-half of the amount of the United 
States bonds held by the association which have been purchased from 
national banks, and which had previously been deposited by such 
banks to secure their circulating notes, shall be deducted from the 
amount of such liabilities. 

Sec. 43. The National Reserve Association shall make a report, 
showing the principal items of its balance sheet, to the Comptroller 
of the Currency once a week. These reports shall be made public. 
In addition, full reports shall be made to the Comptroller of the Cur- 
rency by said association coincident with the five reports called for 
each year from the national banks. 

Sec. 44. All subscribing banks shall, under regulations to be pre- 
scribed by the National Reserve Association make a report monthly, 
or oftener if required, to said association showing the principal items 
of their balance sheets. 

Sec. 45. All reports of national-bank examiners in regard to the 
condition of banks shall hereafter be made in duplicate, and one copy 
shall be filed with the National Reserve Association for the confiden- 
tial use of its executive officers and branch managers. 

Sec. 46. The National Reserve Association may accept copies of 
the reports of the national-bank examiners for subscribing national 



342 APPENDIX II 

banks and also copies of the reports of State-bank examiners for sub- 
scribing State banks and trust companies, in States where the furnish- 
ing of such information is not contrary to law: Provided, however, 
That the standard of such examinations, both National and State, 
meets the requirements prescribed by the National Reserve Associa- 
tion. The National Reserve Association shall have the right at any 
time to examine or cause to be examined by its own representatives 
any subscribing bank. The National Reserve Association may make 
such payments to national and State examiners for such services re- 
quired of them as the directors may consider just and equitable. 

Sec. 47. All provisions of law requiring national banks to hold 
or to transfer and deliver to the Treasurer of the United States bonds 
of the United States other than those required to secure outstanding 
circulating notes and Government deposits are hereby repealed. 

Sec. 48. There shall be no further issue of circulating notes by 
any national bank beyond the amount now outstanding. National 
banks may maintain their present note issue, but whenever a bank 
retires the whole or any part of its existing issue its right to reissue 
the notes so retired shall thereupon cease. 

Sec. 49. The National Reserve Association shall, for a period of 
one year from the date of its organization, offer to purchase at a price 
not less than par and accrued interest the two per centum bonds held 
by subscribing national banks and deposited to secure their circulat- 
ing notes. The National Reserve Association shall take over the 
bonds so purchased and assume responsibility for the redemption upon 
presentation of outstanding notes secured thereby. The National 
Reserve Association shall issue, on the terms herein provided, its own 
notes as the outstanding notes secured by such bonds so held shall be 
presented for redemption and may issue further notes from time to 
time to meet business requirements, it being the policy of the United 
States to retire as rapidly as possible, consistent with the public in- 
terests, bond-secured circulation and to substitute therefor notes of 
the National Reserve Association of a character and secured and re- 
deemed in the manner provided for in this act. 

Sec. 50. All note issues of the National Reserve Association shall 
at all times be covered by legal reserves to the extent required by 
section forty-one of this act and by notes or bills of exchange arising 
out of commercial transactions as hereinbefore defined or obligations 
of the United States. 

Sec 51. Any notes of the National Reserve Association in cir- 
culation at any time in excess of nine hundred million dollars which 
are not covered by an equal amount of lawful money, gold bullion, or 
foreign gold coin held by said association, shall pay a special tax at 
the rate of one and one-half per centum per annum, and any notes 



APPENDIX II 343 

in excess of one billion two hundred million dollars not so covered shall 
pay a special tax at the rate of five per centum per annum: Provided, 
That in computing said amounts of nine hundred million dollars and 
one billion two hundred million dollars the aggregate amount of any 
national-bank notes then outstanding shall be included. 

Sec. 52. The circulating notes of the National Reserve Associa- 
tion shall constitute a first lien upon all its assets and shall be re- 
deemable in lawful money on presentation at the head office of said 
association or any of its branches. It shall be the duty of the National 
Reserve Association to maintain at all times a parity of value of its 
circulating notes with the standard established by the first section of 
the act of March fourteenth, nineteen hundred, entitled "An act to 
define and fix the standard of value, to maintain the parity of all 
forms of money issued or coined by the United States, to refund the 
public debt, and for other purposes." 

Sec. 53. The circulating notes of the National Reserve Associa- 
tion shall be received at par in payment of all taxes, excises, and 
other dues to the United States, and for all salaries and other debts 
and demands owing by the United States to individuals, firms, cor- 
porations, or associations, except obligations of the Government 
which are by their terms specifically payable in gold, and for all debts 
due from or by one bank or trust company to another, and for all 
obligations due to any bank or trust company. 

Sec. 54. The National Reserve Association and its branches shall 
at once, upon application and without charge for transportation, for- 
ward its circulating notes to any depositing bank against its credit 
balance. 

Sec. 55. Upon application of the National Reserve Association 
the Secretary of the Treasury shall exchange the two per centum bonds 
of the United States bearing the circulation privilege purchased from 
subscribing banks for three per centum bonds of the United States 
without the circulation privilege, payable after fifty years from the 
date of issue. The National Reserve Association shall hold the three 
per centum bonds so issued during the period of its corporate exist- 
ence: Provided, That after five years from the date of its organization 
the Secretary of the Treasury may at his option permit the National 
Reserve Association to sell not more than fifty million dollars of such 
bonds annually: And provided further, That the United States reserves 
the right at any time to pay any of such bonds before maturity, or to 
purchase any of them at par for the trustees of the postal savings, or 
otherwise. 

Sec. 56. The National Reserve Association shall pay to the Gov- 
ernment a special franchise tax of one and one-half per centum annually 
during the period of its charter upon an amount equal to the par 



344 APPENDIX II 

value of such United States bonds transferred to it by the subscribing 
banks. 

Sec. 57. That banking corporations for carrying on the business 
of banking in foreign countries and in aid of the commerce of the 
United States with foreign countries and to act when required as 
fiscal agents of the United States in such countries may be formed by 
any number of persons, not less in any case than five, who shall enter 
into articles of association which shall specify in general terms the 
object for which the banking corporation is formed and may contain 
any other provisions not inconsistent with the provisions of this sec- 
tion which the banking corporation may see fit to adopt for the regu- 
lation and conduct of its business and affairs, which said regulations 
shall be signed, in duplicate, by the persons uniting to form the bank- 
ing corporation and one copy thereof shall be forwarded to the Comp- 
troller of the Currency and the other to the Secretary of State, to be 
filed and preserved in their offices. 

That the persons uniting to form such banking corporation shall 
under their hands make an organization certificate which shall specify, 
first, the name assumed by such banking corporation, which name 
shall be subject to approval by the comptroller; second, the foreign 
country or countries or the dependencies or colonies of foreign coun- 
tries or the dependencies of the United States where its banking opera- 
tions are to be carried on; third, the place in the United States where 
its home office shall be located; fourth, the amount of its capital stock 
and the number of shares into which the same shall be divided; fifth, 
the names and places of residence of the shareholders and the number 
of shares held by each of them; and, sixth, a declaration that said 
certificate is made to enable such persons to avail themselves of the 
advantages of this section. 

That no banking corporation shall be organized under the pro- 
visions of this section with a less capital than two million dollars, 
which shall be fully paid in before the banking corporation shall be 
authorized to commence business, and the fact of said payment shall 
be certified by the Comptroller of the Currency and a copy of his cer- 
tificate to this effect shall be filed with the Secretary of State : Provided, 
That the capital stock of any such bank may be increased at any 
time by a vote of two-thirds of its shareholders with the approval of 
the Comptroller of the Currency and that the capital stock of any 
such bank which exceeds two million dollars may be reduced at any 
time to the sum of two million dollars by the vote of shareholders 
owning two-thirds of the capital. 

That every banking corporation formed pursuant to the provisions 
of this section shall for a period of twenty years from the date of the 
execution of its organization certificate be a body corporate, but shall 



APPENDIX II 345 

not be authorized to receive deposits in the United States nor transact 
any domestic business not necessarily related to the business being 
done in foreign countries or in the dependencies of the United States. 
Such banking corporations shall have authority to make acceptances, 
buy and sell bills of exchange, or other commercial paper relating to 
foreign business, and to purchase and sell securities, including securi- 
ties of the United States or of any State in the Union. Each banking 
corporation organized under the provisions of this section shall have 
power to establish and maintain for the transaction of its business a 
branch or branches in foreign countries, their dependencies, or the de- 
pendencies of the United States at such places and under such regula- 
tions as its board of directors may deem expedient. 

A majority of the shares of the capital stock of such banking cor- 
poration shall be held and owned by citizens of the United States or 
corporations chartered under the laws of the United States or of any 
State of the Union, and a majority of the members of the board of 
directors of such banking corporations shall be citizens of the United 
States. Each director shall own in his own right at least one hundred 
shares of the capital stock of the banking corporation of which he is 
a director. 

Whenever the Comptroller shall become satisfied of the insolvency 
of any such banking corporation he may appoint a receiver who shall 
proceed to close up such corporation in the same manner in which he 
would close a national bank, the disposition of the assets of the branches 
to be subject to any special provisions of the laws of the country un- 
der whose jurisdiction such assets are located. 

The annual meeting of every such banking corporation shall be 
held at its home office in the United States, and every such banking 
corporation shall keep at its home office books containing the names 
of all stockholders of such banking corporation and members of its 
board of directors, together with copies of the reports furnished by it 
to the Comptroller of the Currency exhibiting in detail and under 
appropriate heads the resources and liabilities of the banking corpora- 
tion. Every such banking corporation shall make reports to the 
Comptroller of the Currency at such times as he may require, and 
shall be subject to examinations when deemed necessary by the Comp- 
troller of the Currency through examiners appointed by him; the 
compensation of such examiners to be fixed by the Comptroller of the 
Currency. 

Any such banking corporation may go into liquidation and be 
closed by the vote of its shareholders owning two-thirds of its stock. 

Any bank doing business in the United States and being the owner 
of stock in the National Reserve Association may subscribe to the 
stock of any banking corporation organized under the provisions of 



346 APPENDIX II 

this section, but the aggregate of such stock held by any one bank 
shall not exceed ten per centum of the capital stock of the subscribing 
bank. 

Sec. 58. Congress reserves the right to alter or amend the pro- 
visions of this act to take effect at the end of any decennial period 
from and after the organization of the National Reserve Association. 

Sec. 59. All acts or parts of acts inconsistent with the provisions 
of this act are hereby repealed. 



INDEX 



Acceptances, 272-274, 219, 281-283; 
trade, 282. 

Act, of 1870, Refunding, 4, 5; of 1875, 
Redemption, 5, 51; of 1878, 6, 51; 
of 1882, 24; of 1890, 9, n. 1, 11-13, 
17, 51, 149; of 1893, 9, n. 1; of 1898, 
Spanish War Loan, 5, 13; of 1907, 
24, 41, n.; of September 7, 1916, 

287, 292, 296; June 21, 1917, 287, 

288, 292, 304, 309; of September 26, 

1918, 289, 290; of December 24, 

1919, Edge, 296. 

Aidrich, Senator, 54, 55, 57, 68, 69, 
125, 145, 147, 152. See Nat. Mon. 
Com. 

Aldrich-Vreeland Act, 50-80, 127, 
143, 192, 301; currency associa- 
tions of, 60, 64-66, 125, 143. 

American Bankers' Association, bill 
of, 37, 39, 45-47, 50, 160, 220, 246, 
293, n. 1. 

Baltimore Plan, 27-30, 32, 36. 

Bank of England, 128-129; in time 
of panic, 43, 44, n., 135, 140, 141; 
act of 1844, 257, 315; agent of Re- 
serve Bank, 297; fiscal agent, 298; 
gold behind notes of, 305. 

Bank of France, 128-129, 136-137, 
189, 236; agent of Reserve Bank, 
297. 

Bankers' bills, 175. 

Banking, evolution of, 1, 19, 20, 38, 
50,81; prejudice against, 33; func- 
tions of, confused, 157-159. 

Bank-notes, supposed pivotal, 20; 
seasonal demand for, 25; issue of, 
when needed, 39, 47; bond-secured, 
inelastic, 23, 63, 166; no remedy 
for panic, 41-43, 47, 127-131, 143; 



secured by commercial paper, 65- 
80; elasticity of, 126; marginal 
elasticity of, 138-140; functions of, 
243-244; leaning to, in war, 297. 

Banks, profits of, 22, 32-33; services 
rendered by, 108. 

Bonds, of United States, in 1900, 5, 6; 
how payable, 4, 7; extended 2s, 17; 
for securing notes, 17, 65; prices of, 
21; security for public deposits, 41; 
scarce, 64; Panama, 53; railway, 
69, 70. 

Bryan, W. J., 52, 102, 115, 119, 146, 
149, 150. 

Burton, T. E., 59. 

Canadian banking, 25, 177. 

Carlisle, Secretary, 29, 34. 

Clearing-house, certificates of, 38, 40, 
53, 74, 79, 127, 134, 139, 283, 301. 

Clearings, 212-215, 268-271, 291-293. 

Cleveland, President, 51, 149. 

Commercial paper, 66-79, 262-263. 

Cortelyou, Secretary, 65. 

Credit, elasticity of, 19, 26, 143, 161- 
162, 165; centralization and con- 
trol of, 163, 165; in Federal Reserve 
Act, 257-264, 308-311. 

Crisis, in, need is lending power, 44; 
proposed remedy for, 31-32, 39, 41, 
47-48, 92; to prevent, 137-142; 
cause of, 34, 95; of 1893, 1, 19, 40; 
of 1907, 38-49, 52, 63-64, 74, 81- 
83, 95; of 1907, led to monetary 
reform, 124; need of bank-notes 
in, 1907, 127; three important hap- 
penings in, 1907, 131-134. 

Currency, system of U. S., defects of, 
161-163, 216; reform, summary in 
1912, 161. 



347 



348 



INDEX 



Democratic party, policy of, 51, 54, 
146, 148, 149, 150, 218, n. 

Deposit-currency, 20, 26, 31, 38-39, 
46, 86. 

Dunbar, C. F., 245, n. 

Edge Act, December 24, 1919, 296. 

Elasticity, meaning of, 19; over- 
emphasized, 26; of national bank- 
notes, 20-27; of Canadian and 
Scotch bank-notes, 25; of credit, 
26, 27; in both demand-liabilities, 
32; lacking in 1907, 127; of note- 
issues not a remedy for panics, 31- 
32, 43, 47-48, 127-131; marginal, 
40, 138; in proposed bill, 187; of 
Federal Reserve notes, 239, 260. 

Federal Land Bank, 285. 

Federal Reserve Act, 20, 22, 27; early 
suggestion of, 140-142; political 
history of, 143-159; preliminary 
draft of, 150-151; origin of, 151- 
153, 160-215; memorandum on 
political situation, 153-154; how 
related to clearing-houses, 164-165; 
organization and control, 217-229, 
278; powers of board, 221; ques- 
tion of central bank, 227, 236; 
powers of Reserve Banks, 230; 
agents in placing loans, 298; elec- 
tion of directors, 232; dislike of 
rediscounting, 234; open-market 
dealings, 235, 283; confirmed gold 
standard, 3, 237-238; Federal Re- 
serve notes, 238-245, 301-307; 
Federal Reserve Bank notes, 302; 
expansion under, 243-245, 264-268, 
299-304, 307, 308-317; disposal of 
bonds to secure notes, 245-249; re- 
serves, 249-256, 265, 285, 288, 295, 
305; reserve for both notes and 
deposits, 16, 106, 135, 189, 256, 288, 
305, 316; elasticity of credit, 257- 
264; clearings, 268-271, 291-294; 
discount market, 272-274, 283; 
foreign banking faculties, 274, 296; 
independent treasury, 275, 298, 301; 
inducements to State banks, 276, 



286, 287, 288-290; in panic of 1914, 
278; kinds of paper rediscounted, 
279; rates of discounts, 284; prefer- 
ential on war paper, 284-285, 300, 
309, 313; meaning of par list, 293; 
gold settlement fund, 293-294; 
transfers, 293; convertibility into 
gold, 295, 304, 314; effect of war, 
297-301; government ^deposits, 
298. 

Finance bills, 74, 175. 

Fowler Bill, 39, 45, 47, 50, 57-59, 61, 
83. 

Free-Banking Act, 1838, 189. 

Glass, Carter, 147, 149, 151, 153, 160, 
218, 245. 

Gold, production of, 1850-1893, 30; 
not scarce, 42; basis, 294-296; in 
foreign agencies, 297. See Standard. 

Gregory, Attorney-General, 292, n. 2. 

Guaranty of deposits, purpose of, 82- 
83; origin of, 82, 90; forbidden to 
national banks, 85, 120; different 
positions of noteholder and deposi- 
tor, 85-86; depositor, a voluntary 
creditor, 87-88; plan socialistic, 89- 
91; safety of deposits depends on 
assets, 92, 94, 109; no remedy for 
panics, 92-96; justice of, 88, 108- 
110, 115; not for savings-banks, 84; 
immediate redemption impossible, 
83, 105, 112; and note-issues, 97- 
100, 122; results in bad banking, 
100-103, 116-118; viewed as tech- 
nical insurance, 104; and Safety 
Fund Act, 105; now exists, 111; 
no absolute security, 113; in Okla- 
homa, 112, 118; as affecting State 
banks, 120-121; and postal sav- 
ings, 121. 

Independent subtreasury, 208-209; 
in Reserve Act, 275, 298; not abol- 
ished, 301. 

Inspections, 103. 

Investment securities as assets, 158. 

Issue and redemption in Treasury 
separated, 15-16. 



INDEX 



349 



La Follette, Senator, 56. 

Legal tender, and standard, 6, 7; of 

silver dollars, 8. 
Lending power, 44, 124-142, 202. 

MacVeagh, Secretary F., 66, n., 125, 

143. 
McAdoo, Secretary, 247, n., 248. 
Monetary and fiscal functions, 15; 

confused by Federal Reserve Act, 

16; should be separated, 138. 
Monetary Commission, Indianapolis, 

36-37, 50, 57, 160. 
Monetary legislation, methods of, 

155-157. 
Money, function of, 33-34; scarcity 

of, 42; errors about, 33-36. 

National bank notes, why inelastic, 
20-26, 38; redemption of, 24; de- 
pendent on profit to bank, 21 ; lim- 
ited by supply of bonds, 23; con- 
traction of, delayed, 24; relation 
to silver currency, 48; to be re- 
placed by Reserve notes, 238, 241- 
243, 302. 

National Citizens' League, 148, n. 

National Monetary Commission, 61, 
124, 134, 137, 144, 162, 228, 249, 
272; origin of plan of, 145; fell 
dead, 147; relation to Federal 
Reserve Act, 152. 

Note-brokers, 78, 263. 

Owen, Senator, 246. 

Parity between gold and silver, 9-14. 
Pujo, 147. 

Redemption Fund, 75. 
Republican party, policy of, 51-52, 
146, 149. 



Reserves, fixed, 35; not scarce, 42; 
means to increase, 44^15; how ob- 
tained, 45; general principles of, 
201-204; in Federal Reserve Act, 
249-256, 305. 

Roosevelt, President, 53. 

Scott, W. A., 253, n. 

Shaw, Secretary, 248, n. 

Silver, 2, 3, 4, 5, 8; parity with gold, 
8-14, 237; rise in 1919, 12 n., 48; 
private contracts payable in, 8. 

Soetbeer, A., 30. 

Sprague, O. M. W., 244, n. 

Standard question, 1; meaning of, 3; 
progress from, to credit, 1, 19; 
Gold Standard Act, 1900, 2, 4, 5, 6, 
8, 14, 15, 19, 36, 48, 52; established 
by Federal Reserve Act, 3, 237-238. 

Tax on circulation, 17, 71-72, 75. 

Trade paper, 76. 

Transfers, 293. 

Treasury board, 165-172, 176-180; 

relations to district associations, 

181-184. 
Treasury notes, in proposed bill, 184- 

198; not in reserves, 203; treasury 

notes of 1890, 9, 11, 13, 14, 16; 

why disappeared, 12-14. 

Untermyer, S., 147. 

U. S. Bank, Second, 51. 

U. S. notes, 4, 10, 11, 14, 16, 20; re- 
tirement of, 35-36; inelastic, 38, 
237; should be withdrawn, 35, 237. 

War Finance Corporation, 280, n., 

300, 307, n. 3. 
Willis, H. P., 151. 
Wilson, Woodrow, 146, 147, 148, 149, 

150, 153, 154, 219, 226, 290. 



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